Dividend stripping was extremely popular till dividend stripping was virtually abolished when Mr. Chidambaram was the finance minister. This is how dividend stripping worked. An investor buys units worth Rs.50,000 of an equity fund. After a few days, the fund declares dividend and the investor received Rs.5,000 as dividend. The dividend will reduce the value of his investment to Rs.45,000 but then the investor has already received Rs.5,000 as tax free dividend. Now he sells the units at Rs.45,000 and books a loss of Rs.5,000. This loss is used to write off against gains on other short term sources.

However, the government opted to put a bar on this practice. To prevent tax avoidance through dividend stripping, capital loss set off is not allowed under Income Tax Act, if investment was made within 3 months of dividend record date or redemption was made within 9 months of the dividend record date. This has made dividend stripping largely unviable.