The Income Tax Appellate Tribunal, Ahmedabad, has clarified that Section 94(7) of the Income Tax Act, 1961, disallows capital losses to the full extent of dividends received, irrespective of whether such dividends are exempt or taxed at a concessional rate. This ruling reinforces the anti-avoidance intent of the provision and sets a critical precedent for transactions involving dividend stripping in equity and mutual fund investments.
Background & Facts
The Dispute
The appellant, Punita Kalpesh Patel, filed her return of income for Assessment Year 2018-19 declaring a total income of Rs. 302.66 crore, primarily comprising long-term capital gains (LTCG) of approximately Rs. 749.98 crore from the sale of unlisted shares of M/s. Acculife Healthcare Pvt. Ltd. These gains were offset by short-term capital losses (STCL) of Rs. 380.74 crore from the sale of listed equity shares and equity-oriented mutual fund units. During the year, she received dividends of Rs. 470.67 crore from domestic listed shares and Rs. 771.24 crore from mutual fund units. Of the share dividends, Rs. 10 lakh was claimed exempt under Section 10(34), while the balance of Rs. 460.67 crore was offered to tax at 10% under Section 115BBDA, with tax paid accordingly. Mutual fund dividends were claimed exempt under Section 10(35).
Key Facts
- The appellant claimed STCL of Rs. 380.74 crore against LTCG.
- The Assessing Officer (AO) identified transactions where shares were purchased within three months before the record date and sold within three months after, and mutual fund units were purchased within three months before and sold within nine months after.
- For shares, the AO found Rs. 470.67 crore in dividends received from 275 scrips met the conditions under Section 94(7).
- For mutual funds, Rs. 60.70 crore in dividends from two schemes (ICICI Pru Equity Arbitrage DR and BSL Enhanced Arbitrage Fund) were identified as qualifying.
- Total disallowance of STCL: Rs. 531.37 crore.
- The AO also increased the deduction under Section 54F by Rs. 60.70 crore to neutralize the impact of mutual fund disallowance.
- The appellant submitted annexures claiming only Rs. 32.77 crore of share dividends qualified under Section 94(7), arguing that the provision applied only to the exempt portion of dividends.
Procedural History
- 06-08-2018: Return filed for A.Y. 2018-19.
- 2020-21: Assessment under Section 143(3) read with Section 144B.
- 17-09-2025: CIT(A) confirmed the AO’s addition of Rs. 531.37 crore under Section 94(7).
- 20-01-2026: Hearing before ITAT Ahmedabad.
- 13-03-2026: Judgment pronounced.
Relief Sought
The appellant sought deletion of the entire addition of Rs. 531.37 crore under Section 94(7), arguing that the provision should apply only to the exempt portion of dividends (Rs. 10 lakh for shares) and that only Rs. 32.77 crore of transactions met the statutory conditions.
The Legal Issue
The central question was whether Section 94(7) of the Income Tax Act, 1961, applies only to the exempt portion of dividends received under Section 10(34) and Section 10(35), or whether it disallows losses to the full extent of all dividends received, including those taxed under Section 115BBDA.
Arguments Presented
For the Appellant
The appellant’s counsel, Shri S.N. Soparkar, contended that:
- Section 94(7) was designed to prevent tax avoidance arising from exempt dividends.
- Since Section 115BBDA imposes a 10% tax on dividends exceeding Rs. 10 lakh, the taxed portion does not confer a "double benefit" and should not trigger disallowance.
- Only Rs. 32.77 crore of dividend income met the timing conditions, and the AO’s computation included transactions outside the statutory periods.
- The AO erred in using calendar days without excluding weekends and holidays.
For the Respondent
The Revenue’s counsel, Shri Abhijit, argued that:
- The language of Section 94(7) refers to "dividend or income received or receivable" without any qualification as to tax status.
- The provision’s purpose, as stated in the Explanatory Memoranda to the Finance Acts of 2001 and 2004, is to neutralize artificial losses arising from dividend stripping, regardless of whether the dividend is exempt or taxed.
- The Supreme Court in CIT v. Walfort Share & Stock Brokers Pvt. Ltd. [2010] 326 ITR 1 upheld the broad anti-avoidance intent of Section 94(7).
- Even taxed dividends benefit from lower effective rates (10%) compared to capital gains tax rates (15% or 20%), enabling tax arbitrage.
The Court's Analysis
The Tribunal examined the statutory language of Section 94(7), which states: "the loss, if any, arising to him on account of such purchase and sale... to the extent such loss does not exceed the amount of dividend or income received or receivable... shall be ignored."
"The language is clear - the disallowance applies to the 'amount of dividend or income received or receivable,' without qualifying it as 'exempt' dividend."
The Tribunal rejected the appellant’s narrow interpretation, noting that the provision was introduced to combat dividend stripping - a practice where taxpayers generate artificial losses to offset taxable gains while retaining dividend income. Even when dividends are taxed under Section 115BBDA at 10%, the effective tax burden remains lower than the 15% or 20% rates applicable to short-term or long-term capital gains. Allowing full set-off of losses would therefore still enable tax avoidance.
The Tribunal relied on the Supreme Court’s decision in CIT v. Walfort Share & Stock Brokers Pvt. Ltd., which affirmed that Section 94(7) is a specific anti-avoidance provision meant to disregard losses to the extent of dividends received, irrespective of their tax treatment.
"The mischief sought to be prevented by Section 94(7) would continue even where dividend is partly taxable."
The Tribunal also examined the transactional data submitted by the AO and the appellant. While the appellant claimed only Rs. 32.77 crore of dividends qualified, the Tribunal found the AO’s detailed analysis - covering 275 share scrips and 125 mutual fund schemes - was meticulous and corroborated by purchase and sale dates. The appellant’s calculations were found to be flawed, including incorrect exclusion of calendar days and omission of qualifying transactions in companies like Bharat Forge and Reliance Industries.
The burden of proof under Section 101 of the Evidence Act, applicable in tax proceedings, lies on the assessee to disprove the AO’s findings. The Tribunal held that the appellant failed to discharge this burden.
The Verdict
The appeal was dismissed. The Tribunal upheld the addition of Rs. 531,37,390 under Section 94(7), confirming that the disallowance applies to the entire dividend received, whether exempt under Section 10(34) or Section 10(35), or taxed under Section 115BBDA. The adjustment to Section 54F deduction was also sustained. The grounds relating to interest under Sections 234B, 234C, 234D and penalty under Section 270A were held to be consequential or premature.
What This Means For Similar Cases
Dividend Stripping Cannot Be Masked by Taxed Dividends
- Practitioners must now treat Section 94(7) as applying to the full dividend amount, regardless of whether it is exempt or taxed.
- Taxpayers cannot claim that taxed dividends under Section 115BBDA are immune from disallowance.
- Any transaction meeting the timing conditions (purchase within 3 months before record date, sale within 3/9 months after) will trigger full disallowance.
Burden of Proof Rests Heavily on the Assessee
- Detailed transaction logs with exact dates are mandatory.
- Calendar days must be used without excluding weekends or holidays.
- Selective exclusion of transactions will not suffice; the burden is to rebut the AO’s comprehensive analysis.
Strategic Planning for Capital Loss Utilization
- Investors must avoid structuring equity or mutual fund purchases around record dates if capital loss set-off is intended.
- Holding periods beyond the 3-month (shares) or 9-month (units) window must be strictly maintained.
- Tax planning should now separate dividend income strategies from capital loss harvesting.
