Under the anti-tax avoidance provisions (Section 94(8)) of the Income Tax Act, under what specific conditions is a capital loss arising from bonus stripping disallowed against capital gains?

[ A ]If original units are held for more than 10 years and sold at a profit during a financial crisis.

[ B ]If bonus units are gifted to a charitable trust registered under Section 12AA of the Income Tax Act.

[ C ]If the investor invests exclusively through Systematic Investment Plans (SIP) in debt liquid funds.

[ D ]If original units are acquired within 3 months prior to the record date of the bonus issue, and all or any of the original units are sold at a loss within 9 months after the record date.[ CORRECT ]

Takeaway

Option D is correct: If original units are acquired within 3 months prior to the record date of the bonus issue, and all or any of the original units are sold at a loss within 9 months after the record date.

Derivation

Section 94(8) of the Income Tax Act disallows artificial capital losses engineered through bonus stripping. If an investor buys mutual fund units within a period of 3 months prior to the record date of a bonus issue, receives free bonus units, and then sells the original units (which fell in NAV post-bonus) at a loss within 9 months after the record date while retaining the bonus units, the resulting capital loss is completely disallowed for tax set-off. The disallowed loss is treated as the cost of acquisition of the bonus units. This tests anti-avoidance rules. The common error is confusing the 3-month/9-month timeframe.

Why the others fail

A — If original units are held for more than 10 years and sold at a profit during a financial crisis.

Long-term holdings (>10 years) sold at a profit generate legitimate taxable capital gains, not disallowed bonus-stripping tax losses.

B — If bonus units are gifted to a charitable trust registered under Section 12AA of the Income Tax Act.

Gifting units to registered charitable trusts is governed by trust gift rules and does not trigger commercial bonus stripping provisions.

C — If the investor invests exclusively through Systematic Investment Plans (SIP) in debt liquid funds.

Standard SIP investments in liquid funds do not issue bonus shares to engineer artificial capital losses for tax avoidance.