Careful! Your MF dividend may be taxable

There are often times when the dividend payment on a mutual fund looks very tempting. This will result in a situation where the individual might think of undertaking a transaction whereby they are able to book short term capital loss and also earn dividend in the process. This might seem to be easy on first look but there are provisions in the Income Tax Act whereby this will not be allowed. The effort of the individual will be covered under the term dividend stripping and here are some conditions related to the whole exercise that will help in the proper understanding of the situation.

Overall working
The whole idea behind the exercise for the individual is that they are able to save some tax based on the nature of working of the mutual fund but this is called dividend stripping in tax terminology that is not allowed. In case of a mutual fund the Net Asset Value (NAV) of the fund will change when there is some action related to the fund. This means that if there is a dividend that is declared by the fund then the net asset value of the fund will fall to the extent of the dividend declared. In the overall sense there is no impact for the individual in case of a dividend because the payout received by them in the form of the dividend will compensate for the loss that might be witnessed in terms of the drop in the net asset value of the fund. The investor thinks that the move is beneficial because the dividend is not taxable in their hands while the reduction in the net asset value could lead to a situation where the books show a short term capital loss. Time before and after dividend
There are a couple of conditions that need to be followed by the individual in order to ensure that the capital loss is actually allowed to be set off against some other capital gain. The first condition is that the purchase of the units of the mutual funds had taken place before a certain time period of the record date of the dividend then this would not be eligible for the short term capital loss set off benefit. The time period before the dividend has been fixed at three months. The other condition is that the units should be held for a period of nine months after the record date of the dividend and if this condition is violated then once again the benefit will be denied to the individual. So the way in which the entire position will work is that either the units have to be purchased more than three months before the record date. If this is not the case then they have to be held for a period of more than nine months after the record date. Consideration of the loss
The whole idea behind this move of having time limits present for the purpose of holding of the securities is that there should not be misuse of the provision of the set off. Investors should not be able to just transfer the gain that they earn to the tax free route of a dividend and then claim a set off and get double benefit. However if the transaction is genuine and the investor has actually suffered such a loss then the benefit should not be denied to them. This is important because the time period of three months before and nine months after is meant to ensure that the investor has actually held the units for a sufficiently long period of time that will not constitute a situation where there is actually just a book entry of a loss. IF the investor actually holds the units for this time period then the loss would be genuine and hence would have to be allowed.