MFs under Sebi lens for dividend stripping

Mutual funds resorting to the practice of dividend stripping have come under the scanner of market regulator Securities and Exchange Board of India (Sebi) yet again. In an email sent on Wednesday, the regulator has asked fund houses to confirm in writing by Thursday if they are resorting to such a malpractice or not.

According to sources, the regulator has taken the step after being nudged by the finance ministry to look into the matter a few days ago. This, they say, could imply that the government might change the current guidelines to do away with the practice of dividend stripping in the upcoming Budget.

The email by Sebi cites a newspaper article written in November last year which stated that between April 2014 and October 2015 about Rs 25,000 crore was collected in dividend stripping schemes, creating an accounting book loss of more than Rs 8,000 crore. From November to December, about Rs 4,000 crore has been collected in dividend stripping schemes, said sources.

Dividend stripping refers to the practice of using dividends declared by a scheme to lower one's tax liability. Investors essentially pocket the dividend and show reduction in the net asset value (NAV) as capital loss to be adjusted against capital gains from any other investment.

“Dividend stripping is a quick way of shoring up assets. It is also a way of favouring select corproates and high net worth individuals, who can use it as a tax-saving tool,” said a fund official on condition of anonymity.

As per current norms, investors can claim the notional loss caused by the dividend payment if the units are bought three months before the record date or are held for at least nine months after the dividend is paid.

Dividend stripping has gained momentum after industry body Association of Mutual Funds in India asked fund houses to stop offering the bonus option as part of their schemes in May last year. “Back then, Amfi had asked fund houses to stop the bonus plan option and stop taking money into such plans from immediate effect. This had virtually stopped the practice, resulting in some players shifting their attention to dividend stripping,” said a fund official.

Bonus stripping had come into the limelight in 2014 after a single arbitrage scheme collected about Rs 5,000 crore in assets.

Bonus stripping is the purchase of units three months before the record date and selling the original units at a loss or lower value after the bonus is paid. This loss can be used to offset capital gains from other assets. The bonus units are held and sold after another nine months. The process is similar for dividend stripping, except investors do not have to hold any units after the dividend is declared.