According to sources, dividend-stripping has led to major revenue losses of more than around Rs 5,000 crore to the exchequer. Sources added that after subscribing to the units, unit-holders sell them off within a day or two, thus making a dividend and a short-term capital loss. While one need not pay tax on dividend, short-term loss also gets adjusted against capital gains.

Besides, the short-term capital loss comes in handy both toward existing capital gains (if any), accruing either to the individual or to the company, or to a firm and provides a cushion to any future capital gains accruing to these parties. It puts both the unit-holder and the mutual fund in a win-win situation.

It may be mentioned that some individuals make frequent sales and repurchases of mutual fund units to take advantage of the benefits of exemption from dividend tax.

Cases of dividend-stripping have become prominent following the exemption of dividend tax in the 1999-2000 Budget. This resulted in the government suffering huge losses.

According to analysts, if this amendment fructifies, dividend-stripping can be reduced as investors will exercise more caution before taking a position in the units as an exit route will not be readily available.

Dividend-stripping involves getting in and out of equity-based schemes, since their dividend is tax-free, in quick succession, whenever there is a reasonably liberal amount of dividend being declared by a mutual fund.

The differential in net asset values of the scheme prior to and after the dividend payment is treated by the tax department as capital loss, which can be conveniently set off against other capital gains made by the investor, thereby reducing tax liability to a certain extent. The loser of course, is the exchequer, point out sources.