Dividend-stripping

Suresh Krishnamurthy

WILL the Income-Tax Act be modified to take cognisance of dividend stripping and, thus, reduce the incentives for indulging in it? This should perhaps not be a concern for mutual fund asset management companies.

What should occupy their minds is how they can prevent such an act from hurting the interests of other investors. In this context, only a handful of funds can say that they have not used dividend declarations to augment their income.

The declaration of tax-free dividends far ahead of the record date, and the aggressive advertisements of such dividend announcements are an invitation to the high-net-worth corporates and individuals to indulge in dividend-stripping. The exit loads fixed by mutual funds for withdrawal within a short period seem to be designed to share the spoils of dividend-stripping between the asset management companies and this class of investors.

An inflow and outflow of funds over a short period, depending on the movement in stock price during that time, can hurt other investors in the fund. The inflows and outflows cannot but have an impact on the portfolio allocation of the fund since the hot money that has flowed in needs to be either kept as cash or deployed gradually.

Both options would involve an impact -- positive or negative -- to be shared among all investors. The question is, if the impact is negative, why should investors pay for it even though only the asset management companies courted these hot flows. Indeed, it would be so much more equitable if the proceeds from exit loads, or a part thereof, are added to the value of the fund as the unitholders may pay a penalty for this act of dividend-stripping.

It would be a pity if legislation is needed to put a stop to these unsavoury practices. If mutual funds themselves, or collectively through the Association of Mutual Funds of India, come out with a stance against these practices it would be much more desirable, and may work to their benefit over the long run in the form of increased investor acceptance.