Section 94(4) of the Income Tax Act, 1961 deals with the loss on sales of shares, securities, or units. It provides that if a person buys or acquires any shares, securities, or units within a period of three months prior to the record date and sells or transfers them within a period of three months after such date, the loss, if any, arising to him on account of such purchase and sale shall be ignored for the purposes of computing his income chargeable to tax.

This provision is aimed at preventing tax avoidance through dividend stripping. Dividend stripping is a practice where a person buys shares or units in a company just before the record date for the purpose of receiving the dividend and then sells the shares or units immediately after the record date to book a capital loss. This loss is then set off against other capital gains to reduce the taxpayer’s tax liability.

The provisions of section 94(4) apply even if the shares, securities, or units are sold or transferred to another person, who then sells or transfers them back to the taxpayer within the specified period of three months.

Example:

Mr. A buys 100 shares of Company B for Rs.100 per share on March 1, 2023. The record date for the dividend is March 31, 2023, and the dividend is paid on April 10, 2023. Mr. A sells the shares on April 20, 2023, for Rs.90 per share.

In this case, Mr. A’s loss on the sale of shares will be ignored for the purposes of computing his income chargeable to tax under section 94(4). This is because he bought the shares within three months prior to the record date and sold them within three months after the record date.

Exception:

The provisions of section 94(4) do not apply if the taxpayer can prove that he bought the shares, securities, or units for bona fide commercial reasons and not for the purpose of dividend stripping.

Conclusion:

Section 94(4) of the Income Tax Act is an anti-avoidance provision that is aimed at preventing taxpayers from booking artificial capital losses on the sale of shares, securities, or units through dividend stripping.

Examples

Example 1:

On January 1, 2023, Mr. A buys 100 shares of Company B for Rs.100 per share. On March 31, 2023, Company B declares a dividend of Rs.5 per share. Mr. A receives a dividend of Rs.500 (100 shares * Rs.5 per share). On April 1, 2023, Mr. A sells his shares of Company B for Rs.90 per share. He makes a capital loss of Rs.1000 (100 shares * Rs.10 per share).

Example 2:

On January 1, 2023, Ms. B buys 100 units of Mutual Fund C for Rs.100 per unit. On March 31, 2023, Mutual Fund C declares a dividend of Rs.5 per unit. Ms. B receives a dividend of Rs.500 (100 units * Rs.5 per unit). On April 1, 2023, Ms. B sells her units of Mutual Fund C for Rs.90 per unit. She makes a capital loss of Rs.1000 (100 units * Rs.10 per unit).

Example 3:

On January 1, 2023, Mr. C buys 100 shares of Company D for Rs.100 per share. On March 31, 2023, Company D declares a dividend of Rs.5 per share. Mr. C receives a dividend of Rs.500 (100 shares * Rs.5 per share). Mr. C continues to hold the shares of Company D. On December 31, 2023, Mr. C sells his shares of Company D for Rs.90 per share. He makes a capital loss of Rs.1000 (100 shares * Rs.10 per share).

In all of the above examples, the loss on sale of shares, securities, or units is subject to the provisions of section 94(4) of the Income Tax Act, 1961. This means that the loss will be disallowed to the extent of the dividend income received by the taxpayer.

Please note that these are just a few examples, and there are many other possible scenarios. It is important to consult with a qualified tax professional to determine the specific tax implications of your individual situation.

Case laws

• Jaswant Singh Uberoi v. JCIT (ITA No. 7015/DEL/2019)

In this case, the assesses had purchased units of a mutual fund within three months prior to the record date and sold them within nine months after the record date. He claimed that he had made a loss on the sale of the units. The assessing officer disallowed the loss on the ground that it was a “dividend stripping” transaction and hence covered by section 94(7).

The assesses appealed to the CIT(A), who upheld the assessing officer’s order. The assesses then appealed to the ITAT.

The ITAT held that section 94(7) would apply only if the dividend or income on the units received or receivable by the assesses was exempt. In the present case, the dividend income was not exempt as it was not received within one year from the date of purchase of the units. Therefore, the ITAT held that the loss incurred by the assesses on the sale of the units was allowable for deduction.

• Wall fort Shares & Stock Brokers Ltd. v. Income Tax Officer (for assessment years 2001-02 and 2000-01)

In this case, the assesses company, which was a member of the Mumbai Stock Exchange, had purchased and sold shares of various companies in the course of its business. The assesses incurred a loss on some of these transactions. The assessing officer disallowed the loss on the ground that it was a “dividend stripping” transaction.

The assesses appealed to the CIT(A), who upheld the assessing officer’s order. The assesses then appealed to the ITAT.

The ITAT held that the mere knowledge of “dividend stripping” in a transaction does not render it to be a tax avoidance strategy, so long as the transactions between the parties take place at arm’s length and the parties act in the ordinary course of their business. The ITAT also held that the loss incurred by the assesses on the sale of the shares was allowable for deduction as it was incurred in the ordinary course of its business.

FAQ QUESTIONS

What is Loss on sales of shares, securities or units?

Loss on sales of shares, securities or units is the difference between the cost of acquisition and the sale price of shares, securities or units. It is a deductible expense under section 94(4) of the Income Tax Act, 1961.

What are the conditions for claiming deduction under section 94(4)?

The following conditions must be satisfied in order to claim deduction under section 94(4):

• The shares, securities or units must be sold on a recognized stock exchange in India.
• The sale must be genuine and bona fide.
• The shares, securities or units must be held in the assesses name for at least 12 months before the sale.
• The loss must be incurred on the sale of shares, securities or units which are not capital assets.

How is the loss on sales of shares, securities or units calculated?

The loss on sales of shares, securities or units is calculated by deducting the sale price from the cost of acquisition. The cost of acquisition is the sum of the following:

• The amount paid for the shares, securities or units.
• The brokerage and other expenses incurred in acquiring the shares, securities or units.

What are the limitations on claiming deduction under section 94(4)?

The deduction under section 94(4) is limited to the following:

• The amount of loss incurred on the sale of shares, securities or units.
• The amount of net income of the assesses.

How to claim deduction under section 94(4)?

To claim deduction under section 94(4), the assesses must furnish the following details in the income tax return:

• The name of the shares, securities or units sold.
• The date of purchase and sale.
• The cost of acquisition and sale price.
• The brokerage and other expenses incurred in acquiring and selling the shares, securities or units.

Examples of Loss on sales of shares, securities or units

The following are some examples of Loss on sales of shares, securities or units:

• An individual sells 100 shares of a company for ₹10 each. The cost of acquisition of the shares is ₹15 each. The loss on sale of shares is ₹5 per share.
• A company sells its investment in shares of another company for ₹10 crore. The cost of acquisition of the shares is ₹12 crore. The loss on sale of shares is ₹2 crore.

FAQ on Loss on sales of shares, securities or units

Q: What is the difference between loss on sale of shares and capital loss?

A: Loss on sale of shares is a type of capital loss. Capital loss is the difference between the cost of acquisition and the sale price of a capital asset.

Q: What are the different types of capital assets?

A: The different types of capital assets are:

• Land and building.
• Shares and securities.
• Gold and silver.
• Debentures and bonds.
• Machinery and plant.

Q: How is capital loss treated for tax purposes?

A: Capital loss can be set off against capital gains of the same year. If there are no capital gains in the same year, the capital loss can be carried forward for up to 8 years and set off against capital gains of those years.

Q: What are the benefits of claiming deduction under section 94(4)?

A: The following are some of the benefits of claiming deduction under section 94(4):

• It can reduce the overall tax liability of the assesses.
• It can be used to offset capital gains of the same year or carried forward for up to 8 years.
• It can be used to claim refund of excess tax paid.