With retrospective effect

Normally, the Budget is presented on the last day of February, and its provisions are applicable from the next financial year. However, this time, because of the elections, the Budget was presented on July 8 of the following financial year "" FY 04-05. And the Bill was finally passed only on August 26.

Now, the problem with all of this is that various provisions have been made applicable from different dates. For example, taxing of gifts over Rs 25,000 from non-relatives as income is effective only from September 1.

Securities Transaction Tax (STT), exemption on long-term capital gains, etc is applicable from October 1. And some provisions are applicable retrospectively from the beginning of the financial year "" April 1, 2004.

Such retrospective applications put investors in a state of disarray. From April 1 to August 26, investors may have made certain investments based on the tax laws as they existed at that point in time.

Now, if they are made to apply a whole new set of laws for actions taken in the past it could leave them at a disadvantage.

One such situation is the law relating to dividend and bonus stripping.

Modified dividend stripping provisions

The modified Section 94(7) has been made effective from April 1, 2004. This means that the provision will be applicable whenever a person sells shares or units after this date and the following four conditions are simultaneously satisfied:

1. The purchase has been within three months before the record date

2. The sale has been within three months in the case of shares and nine months in the case of units, after the record date

3. The dividend is tax-free and

4. The sale results in a loss (naturally, short-term).

If all the four conditions are satisfied, the loss arising on the sale to the extent it does not exceed the exempt income has to be ignored.

For instance, take the following case:

Shares or units purchased on April 4, 2004 at Rs 500, dividend distributed on June 25, 2004 is Rs 15 and sale on August 2, 2004, at Rs 490, resulting in a loss of Rs 10.

This loss shall be ignored for tax purposes and hence will be unavailable for set-off.

However, if the sale on August 2 was at Rs 480, resulting in a loss of Rs 20, only Rs 15 will be ignored and Rs 5 will be allowed to be carried forward for set off against short-term gains or long-term gains in future for eight successive years.

Similarly, if the sale on August 2 was at Rs 510 resulting in a profit of Rs 10, the entire section is not applicable.

New bonus stripping provisions

The newly inserted Section 94(8) deals with bonus stripping. Interestingly, this section has been made applicable only for mutual fund units and not equities. I do not have a clue why this is done "" the reason is anybody's guess.

The stipulation for its applicability is identical with that of dividend stripping as propagated by the new Section 94(7), with only one primary difference:

The loss, if any will also be ignored for the purposes of computing the income chargeable to tax. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of the bonus units.

For clarity, let us take the same instance as dealt with above, but in this case, it is not the dividend but bonus units issued by a mutual fund (MF).

Units (and not shares) purchased on April 4, 2004 at Rs 500; bonus in the ratio of 1:1 distributed on June 25, 2004; and sale of the old base units on August 2, 2004 at Rs 350, resulting in a loss of Rs 150.

This loss will be ignored but the cost of acquisition of the bonus units will be taken as Rs 150.

Overlapping actions with the last fiscal

Section 94(7) and 94(8) are more insidious than they seem. Their retrospective effect is not limited to the current financial year but might fall into the previous year (FY 03-04) too.

This happens because all the conditions taken together can span 12 months in all, thereby making the provisions related to the current Budget applicable to last year as well.

Let us understand this issue clearly by means of examples.

Situation 1: Investing in a MF scheme (doesn't matter whether it is an income scheme or an equity scheme) on January 5, 2004 and receiving the dividend on March 31, 2004.

The investment is sold on April 2, 2004 (FY 04-05). Is the short-term loss arising out of this investment allowed to be set-off against long-term or short-term capital gains FY 2004-05?

Situation 2: Investing in a MF scheme on January 5, 2004 and the bonus is received on March 31, 2004. The original units are sold on August 2, 2004. Is the short term loss arising out of the original investment available for set-off?

Situation 3: Investing in a MF scheme on December 1, 2003 and receiving the dividend March 31, 2004. The investment is sold on June 2, 2004. Is the short term loss arising out of this investment allowed to set-off against long-term or short-term capital gains FY 2004-05?

Situation 4: Investing in a MF scheme on December 1, 2003 and receiving the bonus on December 31, 2003. The original units are sold on November 2, 2004. Is the short term loss arising out of the original investment available for set-off?

Solutions

Situation-1 : The units are purchased within three months of the record date. Also, the units are sold within nine months of the record date. It doesn't matter that the sale date falls in the next year. As long as all the conditions laid out by Sec. 94(7) are being satisfied, the section would be applicable and consequently, the loss (to the extent of the dividend received) wouldn't be allowed for set-off.

Situation-2 : This situation is similar to the above, only it deals with bonus units. Again, it is irrelevant which financial year the transactions fall; as long as the conditions of Section 94(8) (in this case) are satisfied, the section is applicable.

Situation-3 : Here,the first condition is not being satisfied, in as much as, the time period between the purchase and the record date for dividend is more than three months. Consequently, Section 94(7) is rendered ineffective and inapplicable.

Situation-4 : In this case, the sale is taking place well after a lapse of nine months after the record date. Hence, like situation 3 above, Section 94(8) is rendered ineffective and inapplicable.

Bottomline

The above analysis has been provided for readers to get a good grip on the ramifications of the new provisions. It is but natural that at all times the purchase and the record date have to necessarily precede the date of sale.

It follows that the provisions of the new Sec. 94(7) and Sec. 94(8) would only be applicable if the date of sale falls in FY 04-05. In other words, if the units have been sold in the previous year, the retrospective aspect will not come into play.

But if you have sold the units in this year or are planning to do so, keep this primer handy.

The author may be contacted at

anshanbhag@yahoo.com