Finance Bill, 2022 proposes to amend section 94(7) and section 94(8) of the Income-tax Act, 1961 (‘Act’) to include shares and stocks and units of Business Trusts and Alternative Investment Funds under its ambit. Thus the scope of the anti-avoidance provisions is widened.
Background of the Provisions of Dividend Stripping under section 94(7) and Bonus Stripping under section 94(8)
Section 94(8) was introduced in the statute by the Finance (No. 2) Act, 2004 to curb the practice of creating short term losses by purchase and resale of securities just before or after the record date of bonus units to set off these losses with other incomes. This is called bonus stripping from which unintended benefits flow to the taxpayers.
To prevent the practice of bonus stripping, section 94(8) provides that the loss on sale of original units where bonus units have been issued, will be ignored and the amount of such loss shall be considered as the cost of purchase or acquisition of the bonus units under the following circumstances-
i) Original units were acquired within a period three months prior to the record date of bonus units,
ii) Bonus units are allotted to the unitholder without any payment on the basis of original unity held on the record date
iii) Unitholder sells or transfer all or some of the original units within a period of 9 months from the record date while continuing to hold all or some bonus units
Similarly, section 94(7) was introduced by the Finance Act, 2001 to prevent tax evasion through dividend stripping from shares and units.
Proposed Amendment to section 94(8)
Presently, the term ‘unit’ is defined to mean a unit of a mutual fund or of the Unit Trust of India (UTI).
Further, the current provisions of sub-section (8) of section 94 of the Act do not apply to bonus stripping undertaken in the case of securities. It is also not applicable to units of Infrastructure Investment Trust (InvIT) or Real Estate Investment Trust (REIT) or Alternative Investment Funds (AIFs) as the definition of the term “unit” has not been modified subsequent to the introduction of provisions relating to REITs, InvITs, etc.
Furthermore, the current provisions of sub-section (7) of section 94 of the Act, i.e. provisions pertaining to dividend stripping, are not applicable to the units of new pooled investment vehicles such as InvIT or REIT or AIFs.
In view of the above, it is proposed to amend sub-section (8) of section 94, pertaining to the prevention of tax evasion through bonus stripping, so as to make the said provision applicable to securities as well.
It is also proposed to amend the Explanation to the said section to modify the definition of unit, so as to include units of business trusts such as InvIT, REIT and AIF, within the definition of units.
For this purpose, Clause 25 of the Finance Bill, 2022 proposes to amend the provisions of section 94(8) and the Explanation to section 94 in the following manner-
Amendment of section 94.
25. In section 94 of the Income-tax Act, with effect from the 1st day of April, 2023,–
(i) in sub-section (8), for the word “units” wherever it occurs, the words “securities or units” shall be substituted;
(ii) in the Explanation,–
(a) for clause (aa), the following clause shall be substituted, namely:–
‘(aa) “record date” means such date as may be fixed by—
(i) a company;
(ii) a Mutual Fund or the Administrator of the specified undertaking or the specified company referred to in the Explanation to clause (35) of section 10; or
(iii) a business trust defined in clause (13A) of section 2; or
(iv) an Alternative Investment Fund defined in clause (b) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992,
for the purposes of entitlement of the holder of the securities or units, as the case may be, to receive dividend, income, or additional securities or units without any consideration, as the case may be,’;
(b) for clause (d), the following clause shall be substituted, namely:–
‘(d) “unit" shall mean,–
(i) a unit of a business trust defined in clause (13A) of section 2;
(ii) a unit defined in clause (b) of the Explanation to section 115AB; or
(iii) beneficial interest of an investor in an Alternative Investment Fund, defined in clause (b) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992, and shall include shares or partnership interests.’.
Explaining the proposed amendments to section 94 related to dividend stripping and bonus stripping
Clause 25 seeks to amend section 94 of the Act relating to avoidance of tax by certain transactions in securities.
It is proposed to amend sub-section (8) of the said section so as to provide that the provisions of the said sub-section shall also be applicable to securities.
It is further proposed to substitute clause (aa) of the Explanation to the said section, so as to substitute the definition of the expression "record date" to mean such date as may be fixed by -
i) a company, or
ii) a Mutual Fund or
iii) the Administrator of the specified undertaking or
the specified company referred to in the Explanation to clause (35) of section 10; or
iv) a business trust as defined in clause (13A) of section 2; or
v) an Alternative Investment Fund as defined in clause (b) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992,
for the purposes of entitlement of the holder of the securities or units, as the case may be, to receive dividend, income, or additional securities or unit without any consideration, as the case may be.
It is also proposed to amend clause (d) of the aforesaid, Explanation to amend the definition of the term “unit”.
These amendments will take effect from the 1st April, 2023 and will, accordingly, apply in relation to the assessment year 2023-2024 and subsequent assessment years.
Reasons for amending the provisions of section 94
The Explanatory Memorandum states that section 94 of the Act contains anti-avoidance provisions to deal with transactions in securities and units of mutual fund which, inter-alia, include dividend stripping and bonus stripping.
However, the current provisions of bonus stripping do not apply to securities, units of InVIT, REIT and AIFs since the definition of units. It only applies to units of a mutual fund. The definition of ‘unit’ is not modified to include these new investment products subsequent to their innovation.
The Memorandum further notes that provisions related to dividend stripping as per section 94(7) are not applicable to the units of new pooled investment vehicles such as InVIT or REIT or AIFs.
The proposed amendments are made with the object to prevent tax evasion through bonus stripping with securities also.
Authors’ Comments
Clause 25 of the Finance Bill, 2022, as reproduced above, modifies section 94(8) only. There is no amendment proposed for section 94(7). However, the proposed amendment also modifies section 94(7).
Readers shall note that the said clause 25 has also modified the Explanation to section 94 by substituting the existing clause (aa) and clause (d). The term ‘unit’ as defined in clause (d) includes all the above new types of investment units.
Section 94(7) which is related to dividend stripping, also covers ‘units’ apart from shares and stocks. Since clause (d) to Explanation is applicable for the entire section 94, the modified definition of ‘unit’ also covers and modifies section 94(7).
Hence, in this manner, clause 25 amends section 94(7) as well as section 94(8), though primarily the amendment is focused on section 94(8).
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