Dividend Stripping & Bonus Stripping: Tax Rules Under Section 94(7) and 94(8)

What Is Dividend Stripping?

Dividend stripping refers to the practice of buying shares or mutual fund units shortly before the record date for a dividend, receiving the dividend, and then selling the units shortly after the record date once the unit price drops (as it typically does, roughly by the dividend amount, since the fund's NAV falls after the payout). The investor receives a tax-free or low-tax dividend while booking a capital loss on the sale, which can then be set off against other capital gains, effectively converting taxable gains into a smaller net liability.

Section 94(7): The Anti-Dividend-Stripping Rule

Section 94(7) disallows the capital loss arising from such a transaction if all three of the following conditions are met:

• The securities or units were acquired within 3 months before the record date
• Any income (dividend or income distribution) was received or is receivable on those securities or units
• The securities or units (or substantially similar units, in case of mutual funds) are sold or transferred within 3 months after the record date for shares, or within 9 months after the record date for units of a mutual fund or UTI

If all conditions are satisfied, the loss is disallowed only to the extent of the dividend or income received. This disallowed loss is added back to the cost of acquisition for future computation, so it is not permanently lost, but it cannot be used to offset gains in the current year.

Worked Example: Dividend Stripping

Section 94(8): The Anti-Bonus-Stripping Rule

A related but distinct strategy is bonus stripping. Here, an investor buys units shortly before a company or fund issues bonus shares or units (additional units issued free of cost to existing holders, which dilutes the per-unit value), and then sells the original units at a loss after the bonus issue, while retaining the bonus units to be sold later at a profit (often after holding long enough to qualify for long-term capital gains treatment).

Section 94(8) addresses this for bonus units of mutual funds (and, by similar logic, bonus shares) where:

• The units were acquired within 3 months before the record date for the bonus issue
• Bonus units were allotted to the investor on the basis of holding those original units
• The original units are sold within 9 months after the record date, at a loss

In this case, Section 94(8) does not allow you to deduct the loss on the original units at all. Instead, the loss is treated as not having arisen, and is added to the cost of acquisition of the bonus units received. This means the loss effectively gets deferred and rolled into the cost basis of the bonus units, reducing the gain (or increasing the loss) when those bonus units are eventually sold.

Worked Example: Bonus Stripping

Why These Rules Matter for Everyday Investors

Many retail investors unknowingly trigger Section 94(7) or 94(8) simply through routine SIP or lump-sum investments timed close to dividend or bonus record dates, without any intent to avoid tax. The provisions apply automatically based on the timing conditions, regardless of intent, so it is worth checking record date calendars before making large purchases in dividend-paying or bonus-prone instruments if you plan to sell within the lookback windows.