Investing your earnings in the stock market is a great way to grow your wealth over a period of time. While it does come with its own set of risks, such investments often let you enjoy higher returns in the long run. If you’re investing in the stock market, one important aspect to account for is the income tax on a demat account. As per the Income Tax Act, 1961, the gains that you derive from selling the shares that you hold in your demat account are liable to be taxed. Read on to find out more about the various implications of income tax on a demat account.
What are the tax implications on demat account?
With respect to the tax implications on demat account, there are four primary aspects that you should be aware of.
Short-Term Capital Gains (STCG)
According to the Income Tax Act, assets that are held for 12 months or less are classified as short-term capital assets. These assets include equity shares, preference shares, debentures, government securities, bonds, and mutual funds, among others. Any gain that you derive from selling these assets within a period of 12 months or less are invariably termed as Short-Term Capital Gains (STCG) and are consequently taxed accordingly.
Therefore, if you hold any of the above-mentioned assets in your demat account and you subsequently sell them within the specified period, you automatically become liable to pay Short-Term Capital Gains Tax. Currently, the rate of tax that is charged on STCG is at 15% for gains on trades where Securities Transaction Tax (STT) is applicable. For special cases where STT is not applicable, the STCG is combined with your Total Taxable Income and then taxed according to your income tax slab.
Long-Term Capital Gains (LTCG)
Capital assets such as equity shares, preference shares, bonds, debentures, mutual funds, and government securities that are held for more than 12 months are categorized as long-term capital assets by the Income Tax Act, 1961. The gains that you acquire upon selling these long-term capital assets are deemed as Long-Term Capital Gains (LTCG).
Similar to the provisions of income tax on a demat account regarding STCG, you are required to pay Long-Term Capital Gains Tax if you sell any of the above-mentioned long-term capital assets in your demat account. At present, LTCG of up to Rs. 1 lakh in a financial year is fully exempt from taxation. LTCG that is over and above Rs. 1 lakh in a financial year attracts a flat rate of tax of 10%.
Short-Term Capital Loss (STCL)
When you sell your short-term capital assets for a price below the purchase price, you invariably incur a capital loss. This loss of capital is classified as Short-Term Capital Loss. The Income Tax Act allows you to set-off such capital loss against either STCG or LTCG incurred in the same financial year.
In the event that the entirety of your STCL is not set-off during the year, the provisions of the Income Tax Act allow you to carry forward the loss for up to 8 financial years. The loss carried forward can then be used to set-off either LTCG or STCG made during that year.
Long-Term Capital Loss (LTCL)
Any capital loss that you incur when you sell your long-term capital assets for below the purchase price is termed as Long-Term Capital Loss. Till recently, the Income Tax Act disallowed the set-off and carry forwarding of LTCL. However, vide a notification dated 4th February 2018, it is now allowed for long-term capital loss to be set-off against LTCG for transfers made on or after 1st April 2018.
Similar to the provisions of STCL, any Long-Term Capital Loss that is not fully set-off can be carried forward for up to 8 subsequent financial years. The carried forward LTCL can be used to set-off only long-term capital gains made during that year.
How to save tax using a demat account?
If you’re wondering about how to save tax using a demat account, here are two of the most sought-after ways using which you can significantly bring down your tax liability.
Investment in ULIPs
A Unit Linked Insurance Plan (ULIP) is a great investment vehicle that offers you the dual benefits of insurance cover as well as wealth creation. A part of the investment that you make in a ULIP goes towards providing you with a life cover, while the other part gets invested in the financial markets. These investments get credited to your demat account, where you’re required to hold them for a minimum of 5 years as part of the mandatory lock-in period.
ULIP investments of up to ₹1.5 lakhs in a financial year are fully exempt from taxation under Section 80C of the Income Tax Act. Additionally, the maturity amount that you receive at the end of the holding period is also fully exempt from taxation. This two-fold tax saving feature of ULIPs can help you effectively nullify the effects of income tax on a demat account.
Investment in ELSS
Equity Linked Savings Scheme (ELSS) is another great tax-saving investment option. Compared to other traditional forms of investment, ELSS has the lowest lock-in period of just 3 years. The returns offered by this scheme are also typically much higher than other investments.
ELSS is the answer to the question of how to save tax using a demat account, since the amount of investment in this scheme is fully exempt up to ₹1.5 lakh in a financial year. Furthermore, the LTCG that you receive at the end of the lock-in period of 3 years is taxable only if it is over and above ₹1 lakh.
Now that you’re aware of the various implications of income tax on a demat account, you can easily decrease your tax liability with just a couple of quick and simple tweaks to your investment strategies. With these techniques, you can continue to enjoy the benefits offered by a demat account without worrying about your tax burden.