To understand better, let us consider an example of a fund declaring an 80per cent dividend with a record date as March 22, 2000. An investment of Rs10,000 at the NAV of say Rs 81.93 as on March 8, will result in owning122.055 units. At the time of exit from the fund soon after the dividend,the NAV will be Rs 73.93 with a fall of Rs 8 per unit on account of dividenddistribution. The investor thus gets a tax-free dividend of Rs 976 and onthe immediate sale of the units, proceeds of Rs 9024 which translates into ashort-term capital loss of Rs 976. Hence, the investor is able to maintainthe status quo on his investments i.e. he invests RS 10,000 and got back Rs10,000 with a notional capital loss and a tax-free dividend.

This short-term capital loss can be used to set off short-term or long-termcapital gains and the balance, if any, can be carried forward for eightyears and set off at a later date.

But many a times, the funds introduce an exit/entry load for short-termperiods in order to discourage dividend stripping. In such a case, dividendstripping will only be possible if, during the time an investor stays in thefund, there is an upward movement in the NAV by the same percentage as theload levied on investments. This will result in a higher ex-dividend NAV andgive the same results as in the first case. Let us suppose there was a 2 percent exit load in the above example. Consider a 2 per cent gain in the NAVto Rs 83.57. With an 80 per cent dividend, the ex-dividend NAV will be Rs75.57. After the 2 per cent exit load, the per unit NAV will be Rs 74.057resulting in proceeds of Rs 9039 and a tax-free dividend of Rs 976.

Further, if the fund declares a bonus with the dividend, it will be an icingon the cake. Let us improvise the second example to include a 1:1 bonus aswell. This will imply an ex-dividend and an ex-bonus NAV of Rs 37.785 and244.1108 units (Two times the original units). Now if the investor sells theoriginal 122.0554 units at Rs 37.785, the transaction will result inproceeds of Rs 4612 and a notional short term capital loss of as high as Rs5388. Since in the case of bonus units, the total sale price will be capitalgains, it makes sense to sell them after 12 months. This not only defers thetax liability but also taxes the gains at a reduced rate of 11 per cent (10per cent + surcharge). There can be other benefits also like setting off, inthe next financial year, capital loss from any other transaction or availbenefit of basic exemption limit if income in next year is expected to belower.

But the strategy can be simple only if there is little uncertainty about theassumptions turning out to be actually true. An inherent risk which, theinvestors will have to assume, would be a turn in the tide of the marketsthat can also result in a fall in NAV and a dilution of investments. But therising markets, despite its volatility, since the beginning of 1999, havereduced the risk of a downturn in the bourses and hence increased the appealof dividend stripping.

Though dividend stripping can be successfully adopted for open-end fundswith more than 50 per cent allocation to equity, for other funds it may notbe true. The other funds have to pay 11 per cent additional tax (increasedto 22 per cent with effect from April, 2000) on proposed dividend therebyreducing the actual distributive surplus for investors. Hence investors ofdebt funds or other funds with less than 50 per cent allocation to equityshould only opt for growth option which does not pay any dividend butre-deploys the earnings of the scheme, thereby enhancing its NAV.

Whenever the units are en-cashed, capital gain arises. However, it will bebetter for investors to encash after 12 months so that the resultant gain istaxed at 11 per cent.

Some of the cases for dividend stripping are: Libra Leap from Credit CapitalAMC carries a 2 per cent load while redemption is at NAV. The fund hasdeclared a maiden 101 per cent dividend as on March 17, 2000. The dividendat the current entry price of Rs 49.419 will result in an instant yield of20.25 per cent.

Birla Advantage carries a 2 per cent entry load and has declared a 80 percent dividend for all investors as on March 22, 2000. The dividend at thecurrent entry price of Rs 78.27 will result in tax-free dividend yield of10.22 per cent. Kothari Pioneer Taxshield (KPTX), an open-ended equitylinked tax-saving scheme, available on a no load basis has declared an 80per cent dividend for the investors as on March 31, 2000. The fund being atax-planning scheme, offers a tax rebate of 20 per cent on a maximuminvestment of Rs 10,000. Thus, an investment of Rs 10,000 at the current NAVlevels of Rs 33.55, will not only get a tax-free dividend of Rs 2384, butfor a marginal tax-payer, a tax rebate of Rs 2000 as well. The dividendalone will give a yield of 23.84 per cent.

But whatever said and done, the returns on investments with a long-termperspective are far higher than the peanut returns on short-term speculativetransactions. Further, funds discourage dividend stripping as it yieldsreturns for the short-term investors at the cost of long term investors.

-- Value Research