2025 (8) TMI 348 - AT - Income Tax

Assessee's Loss Exemption Under Section 10(35) Upheld; Dividend Stripping Rule Section 94(7) Not Applicable

The ITAT Mumbai upheld the CIT(A)'s order allowing the assessee's claim of loss exemption under section 10(35). The AO's disallowance based on alleged ... Exemption u/s 10(35) - assessee had claimed loss under the head of equity/derivative - AO had disallowed the claim of exemption on the ground that assessee had taken accommodation entries since the JM Financial Fund had manipulated accounting methodology so as to artificially inflate the distributable surplus on the basis of period of investment and declaration of dividend within a short period of investment before selling the units as discussed in this order - HELD THAT:- As per the provisions of section 94(7) of the Act, if any persons purchase units of mutual funds three month prior to the record date of dividend and sells any units of mutual funds within a period of nine months from the record date for such dividend the loss if any, on such sale of units would be ignored for computing income chargeable to tax to the extent of dividend income received. Since in the case of the assessee the units of the fund was purchased on 14.10.2024 i.e. more than 3 months prior from date of declaration of dividend therefore the provisions of dividend stripping u/s 94(7) of the Act are not applicable. The AO failed to rebut the supporting documents filed by the assessee as discussed in the order of ld. CIT(A). There is no material on record to take contrary view, therefore, the impugned order of the ld. CIT(A) does not require any interference at our level. Therefore, all the grounds of appeal are rejected. Accordingly, the appeal of the Revenue is dismissed. ISSUES: Whether exemption under section 10(35) of the Income-Tax Act is rightly allowed on dividend income received from mutual fund units despite allegations of manipulated accounting inflating distributable surplus.Whether short-term capital loss claimed on sale of mutual fund units is allowable when the dividend income is alleged to arise from sham transactions involving artificial payout and accounting manipulation.Whether provisions of section 94(7) relating to dividend stripping apply when units were purchased more than three months prior to the record date of dividend.Whether allegations of violation of SEBI guidelines and admission by fund management affect the tax treatment of dividend income and capital loss claimed by the investor.Whether the investor's claim of exemption and capital loss can be denied on the basis of investigation reports and statements implicating the mutual fund house, absent direct evidence against the investor. RULINGS / HOLDINGS: The exemption under section 10(35) of the Income-Tax Act on dividend income of Rs. 3,86,74,033/- was rightly allowed as the dividend received by the assessee from the mutual fund units is exempt income; the statute 'does not provide for reclassification of such dividend as capital gain.'The short-term capital loss of Rs. 3,41,02,141/- claimed on sale of mutual fund units was allowable since the provisions of section 94(7) are not applicable, as the units were purchased more than three months prior to the record date of dividend; thus, the loss cannot be disallowed on the ground of dividend stripping.The allegations of manipulation and violation of SEBI guidelines by the mutual fund house, including admission by key personnel, do not implicate the assessee directly, and in absence of evidence that the assessee knowingly participated in sham transactions, the exemption and loss claims cannot be denied.The provisions of section 94(7) apply only where units are purchased within three months prior to the record date; since this condition was not met, the loss claimed by the assessee cannot be ignored under this section.Investors who are mere recipients of dividend and capital loss without active involvement in manipulation are protected by judicial precedents; thus, reopening of assessment and denial of exemption on such grounds is not justified. RATIONALE: The Court applied the statutory framework of sections 10(35) and 94(7) of the Income-Tax Act, which respectively govern exemption of dividend income from specified mutual funds and the treatment of losses arising from dividend stripping transactions.Section 10(35) explicitly exempts income by way of dividend received from mutual fund units and does not contemplate reclassification of such dividend as capital gains, thereby supporting the exemption claim.Section 94(7) restricts loss claims only where units are acquired within three months prior to the record date and sold within specified periods thereafter; the assessee's purchase predates this period, excluding applicability of the provision.The Court relied on judicial precedents including a ruling of the jurisdictional High Court which held that allegations against a mutual fund house do not automatically implicate individual investors absent evidence of their knowing participation in sham transactions.The Court noted that SEBI had not imposed any restrictions or wound up the scheme, indicating regulatory acceptance despite alleged accounting irregularities, and thereby undermining the basis for denying exemption or loss claims.A judicial pronouncement emphasized that the legislature did not treat dividend stripping transactions as sham or bogus but only limited loss disallowance to the extent of dividend received, preserving genuine loss claims beyond that amount.The Court rejected the Assessing Officer's reliance on investigation reports and statements against the mutual fund house as insufficient to deny the assessee's claims without direct evidence of complicity or manipulation by the assessee.