Tax Implications of Majesco Ltd.’s Dividend Declaration on 15th December 2020

Easy dividend income seemed like a no brainer on 15th December 2020 when the board of Majesco Ltd. declared an interim dividend of Rs. 974 per share, i.e., dividend higher than its prevailing market price of Rs. 972. As retail investors hopped on the share purchase bandwagon to grab the dividend stripping opportunity, the market price of the shares experienced a steep rise on the announcement date.

The viability of the dividend stripping opportunity may be assessed with the help of the following illustration:

Rate per share Number of shares Amount (Rs.)
Purchase price* 900 100 -90,000 A
Dividend 974 100 97,400 B
Inflow / -outflow 74 100 7,400 C

*This assumption is for explanation purposes and exclude brokerage costs.

While a standalone observation makes this investment appear lucrative, the position is reversed when viewed in consolidation with the tax amendments in the Finance Budget 2020, where the Government of India made the dividend income (earlier exempt u/s. 10(34) of the Income Tax Act, 1961) taxable at slab rates w.e.f. F.Y. 2020-21.

Since the above illustrated dividend would be taxed at slab rates in the hands of investors, the post-tax inflow / outflow position for different slab rates would be follows:

Income tax slab rates

(FY 2020-21)*

5% 10% 15% 20% 25% 30%
Dividend tax outflow

(dividend income in B above x slab rate)

4,870 9,740 14,610 19,480 24,350 29,220 D
Post tax inflow / -outflow

(Inflow in C above – tax calculated in D above)

2,530 -2,340 -7,210 -12,080 -16,950 -21,820 E

*applicable cess and surcharge rates have been excluded for ease of understanding.

A post tax view of the dividend stripping opportunity reverses the picture as there is little or no money in the hands of the investors despite the whopping 19,480% dividend. This is because the amount of tax payable exceeds the margin by which the dividend income covers the cost of shares.

Hence, this investment does not appear viable unless the margin by which the dividend income covers the cost of shares exceeds the tax slab rate applicable to the investor.

Note: This tax shall not be applicable in case of a domestic company that has declared dividend on or before the due date of filing return. This is owing to the deduction u/s. 80M of the Income Tax Act inserted w.e.f AY 2021-22 which permits deduction in respect of Inter Corporate Dividends upto the extent of dividend declared by the company. Hence, this illustration will not be applicable for such companies.

The next facet to be considered here is the cash flow position upon liquidating these shares.

The ex-dividend price of the shares is expected to experience a stark fall and the investors could be hoping to set off the short term capital losses (STCL) against capital gains for a tax benefit. However, this too comes with an impediment imposed by the Dividend Stripping provisions u/s 94(7) of the Income Tax Act, 1961.

This section provides that only the STCL which is over and above the dividend income shall be eligible to be set off against capital gains. In other words, the provision restricts the setting off of STCL to the extent of dividend income earned on dividend stripping. This is applicable when:

– the underlying shares are bought within three months prior to the record date of the dividend;

– sold within three months after such date; and

– the dividend income on such security is exempt.

The record date in the present case is 25th December 2020. Therefore, to set off the entire STCL, the investor would have to buy the shares at least three months prior to 25th December 2020 or sell them three months after such date.

(It is pertinent to note that the section becomes applicable only in the case of ‘exempt’ dividend. Since dividend income is no longer exempt, the applicability of this section seems ineffectual. However, in the absence of any clarifications from the department, a conservative view has been taken in this illustration and calculations are made both ways.)

Continuing the illustration to determine the net inflow / outflow on liquidating the holding, an ex-dividend sale price ranging between Rs. -1 to Rs. 100 has been assumed and the STCL calculations have been made accordingly. If section 94(7) is applied If 94(7) is not applied
Ex- dividend sale price per share* Number of shares F

Sale Value
(sale price ex- dividend x number of shares)

Short Term Capital Loss (STCL)
(Sale value in F – purchase price in A above)
Losses permitted to be adjusted as per section 94(7)
(STCL over and above the Dividend income in B above)
G

Tax benefit on such set off
(STCL*15% – Rate of STCG is 15% as per section 111A)

H

Tax benefit on such set off
(STCL*15% – Rate of STCG is 15% as per section 111A)

-1 100 -100 90,100 13,515
10 100 1000 89,000 13,350
50 100 5000 85,000 12,750
100 100 10000 80,000 12,000

*The sale ex-dividend share price is likely to experience a drastic fall and analysts are even considering the possibility of a negative share price. Accordingly, a broad range of ex-dividend prices have been assumed.

Hence, if the department upholds the applicability of Section 94(7), the investors will be unable to avail any tax benefit from setting off the STCL against capital gains unless the STCL exceeds the amount of dividend earned.

To conclude, the final inflow / outflow in the hands of the investors from different slab rates would appear as under:

1. If 94(7) is applied

Net inflow / -outflow (Inflow / outflow in E + Sale value in F + Tax benefit in G) Income tax slab rates
5% 10% 15% 20% 25% 30%
 

Ex-dividend price range per share

-1 2,430 -2,440 -7,310 -12,180 -17,050 -21,920
10 3,530 -1,340 -6,210 -11,080 -15,950 -20,820
50 7,530 2,660 -2,210 -7,080 -11,950 -16,820
100 12,530 7,660 2,790 -2,080 -6,950 -11,820

2. If 94(7) is not applied

Net inflow / -outflow (Inflow / outflow in E + Sale value in F + Tax benefit in H) Income tax slab rates
5% 10% 15% 20% 25% 30%
 

Ex-dividend price range per share

-1 15,945 11,075 6,205 1,335 -3,535 -8,405
10 16,880 12,010 7,140 2,270 -2,600 -7,470
50 20,280 15,410 10,540 5,670 800 -4,070
100 24,530 19,660 14,790 9,920 5,050 180

While the above interim dividend declaration was a smart move by the company to liquidate its holdings and seize the benefit of withdrawn Dividend Distribution Tax provisions, the benefits to investors are not as lucrative as they may appear. Owing to the amended tax provisions, the only shareholders that appear to benefit are the company promotors, or the shareholders falling under a considerably low tax bracket.

Disclaimer : The illustration above is only for educational purposes. It must not be construed as an investment advice as the facts and figures for each investor may vary.

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