Technology has made stock market investing more accessible than ever. To invest in equities, mutual funds, or other securities, both a trading account and a Demat account are typically required.
While a trading account is used for buying and selling securities, a Demat account acts as an electronic repository where these securities are held.
However, many investors remain unaware of the tax implications associated with transactions carried out through these accounts.
How Demat Accounts Work With Trading Accounts?
A Demat account serves as digital storage for the securities you buy through the stock exchange, eliminating the need for physical share certificates.
On the other hand, a trading account facilitates the purchase and sale of securities and acts as a bridge between your bank account and Demat account.
While a trading account is used for executing transactions, the Demat account is essential for holding those securities in electronic form.
How an Account of Demat Accounts Will Affect Your Taxable Income?
Every smart investor should know that any gain or loss from their securities in a demat account is taxable. Here are some important points to keep in mind:
1. Capital Gains Tax
Capital gains tax applies to the sale of securities. The length of time the securities have been held determines whether the gains are classified as short- or long-term.
Short-Term Capital Gains (STCG): If stocks are sold within one year of purchasing them, gains will be classified as short-term and will be taxed at a 15% tax rate.
Long-Term Capital Gains (LTCG): If shares are sold after being held for more than one year, gains above ₹1 lakh will be taxed at 10% without indexation benefits.
2. TDS on Demat Operations
In general, TDS (tax deduction at source) does not apply to your transactions in the stock market, but TDS would be deducted from your dividend amounts if they are credited to a demat account. Hence, if dividend income exceeds ₹5,000 in any financial year, a company deducts TDS at a 10% rate, which should be declared by the investor while filing income taxes.
3. Tax on Dividend Income
In the previous structure, dividends were tax-free in the hands of investors since the companies paid the DDT. Due to the recent amendments, dividends received into a demat account are now taxed as per one’s applicable slab rate.
4. Taxation of Derivative Trading
Trading in derivative instruments (inclusive of futures and options) is treated differently than trading in equities. The profits arising out of trading in derivatives qualify as income from business rather than capital gains. So: Profits are taxed according to income tax slabs. Losses in derivative trading may be carried forward for eight years and adjusted against business income.
Reporting Gains and Losses from Demat Accounts
Investors need to ensure that they appropriately report their trading and demat transactions in their respective Income Tax Returns. This is how:
- Reporting of Capital Gains: Short-term capital gains and long-term capital gains shall be reported under the applicable section in the income tax return.
- Declaration of Dividend Income: Investors have to declare the gross dividend received even if TDS is deducted on it.
- Trading Income as Business Income: The income generated from the trading account should be declared as business income if trading occurs very often or in large volumes.
Failure to report transactions may trigger scrutiny and penalties, and hence, a return should be filed accurately.
Tax-Saving Strategies for Investors
The following tax-saving options can be considered for investment purposes through a demat account:
- Enjoy the ₹1 Lakh Exemption of LTCG Tax: Since long-term capital gains up to ₹1 lakh are exempt, one should plan the transactions in such a way that it maximizes this benefit.
- Set-Off of Losses Against Gains: Losses ought to be set off against gains to lower the tax burden.
- Investment in Tax-Friendly Products: If taxation is a primary concern, one must consider ELSS or index funds.
- Tax Harvesting: Buying and selling of securities can be so timed that there is a realization of long-term capital loss to offset the taxable capital gains on other shares.
Conclusion
A demat account simplifies investment management, but it also comes with tax implications that investors must know about. It becomes necessary for effective financial planning and compliance to have a basic understanding of the taxation of capital gains, dividends, and trading income.
