A secondary demat account can significantly help cut stock taxes by allowing investors to separate their long-term investments from their short-term trades. This helps manage the First In, First Out (FIFO) rule, the standard method for calculating capital gains in India.
How a Secondary Demat Account Helps with Taxes 💸
Previously, all shares were held in a single demat account. When an investor sold a portion of a stock, the FIFO rule automatically assumed that the oldest shares were sold first, regardless of the investor’s intent. This often led to a higher tax bill. For example, an investor might buy shares for a long-term goal at a low price, then later buy more of the same shares at a higher price for short-term trading. If they sell some shares for a quick profit, the FIFO rule dictates that the low-cost, long-term holdings are sold first. This results in a larger short-term capital gain (STCG), which is taxed at a higher rate.
With a secondary demat account, FIFO is applied per account. Investors can transfer their long-term holdings to the secondary account, keeping their short-term trading positions in the primary account. This separation ensures that when they sell shares from the primary account, the FIFO calculation only considers the shares within that account. This allows investors to realize short-term gains on their short-term holdings without affecting their long-term investments.
Key Terms Explained
- Demat Account: An account that holds financial securities like stocks and bonds in an electronic format.
- FIFO (First In, First Out): An accounting method that assumes the first shares acquired are the first ones sold.
- Long-Term Capital Gains (LTCG): Profits from selling shares held for more than 12 months. In India, LTCG on listed equities is taxed at a lower rate of 10% on gains exceeding ₹1 lakh per financial year.
- Short-Term Capital Gains (STCG): Profits from selling shares held for 12 months or less. STCG on listed equities is taxed at a higher rate of 15% in India.
Costs and Other Considerations
While the tax benefits can be substantial, there are some costs and limitations to consider:
- Annual Maintenance Charge (AMC): Each demat account has its own AMC.
- Transfer Fees: Moving shares between demat accounts (off-market transfers) incurs a transaction fee.
- BSDA Eligibility: Opening a secondary demat account makes an investor ineligible for a Basic Services Demat Account (BSDA), which offers reduced or zero maintenance charges for holdings below ₹2 lakh.
Despite these costs, the potential tax savings from correctly managing the FIFO rule can far outweigh the additional fees, especially for active traders and investors.