Demat Account: What are the tax implications of transactions?

Although opening a demat account often comes free of charge these days, it's essential to recognise that maintaining them and actively engaging in transactions, whether it's buying or selling securities, does come at a price. 

While the allure of zero opening fees might initially seem like a win-win situation, it's crucial to understand the financial responsibilities that come with managing a demat account over time. Just when you thought you were diving into the world of investing to grow your wealth, along comes the taxman, ready to take a slice of your profits.

In this article, we'll delve into the different taxes associated with purchasing and selling financial assets. Additionally, we'll answer important questions like whether STT applies even if losses are incurred while trading stocks and what the threshold for exemption on long-term capital gains (LTCG) is.

Capital Gains

Capital gains tax is a type of tax levied on the profits earned from the sale of certain financial assets. This tax is calculated based on the difference between the selling price of the asset and its original purchase price.

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For instance, if you bought a stock for ₹100 and sold it for ₹200, which is higher than your buying price, the profit from this sale is considered as a capital gain. The tax rate applied to capital gains depends on various factors, including the type of asset and the duration for which it was held.

Capital gains are categorised into two main types: 

Short-term capital gains: These are profits earned from the sale of assets that were held for a year or less. Short-term capital gains are typically taxed at higher rates compared to long-term capital gains.

Equity-oriented assets are subject to STCG tax at a flat rate of 15% if held for less than 12 months. For example, if you sell equity shares after holding them for 9 months and earn a profit of ₹20,000, the STCG tax of 15% would apply to this gain.

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Long-term capital gains: These are profits earned from the sale of assets that were held for more than a year. Long-term capital gains often qualify for lower tax rates or may even be subject to special tax treatment designed to incentivise long-term investment.

Capital gains made over a longer duration to the tune of ₹1 lakh for a financial year are exempt; however, a flat 10% tax applies on any gains over and above this amount.

Many investors employ various strategies to minimise their capital gains tax liabilities, such as tax-loss harvesting, holding assets for longer periods to qualify for lower tax rates, or investing in tax-advantaged accounts.

Security Transaction Tax

STT is levied on transactions involving the purchase or sale of securities such as stocks, derivatives, and equity-oriented mutual funds in the Indian stock market. Introduced in India in 2004, STT is collected by the government to help regulate and generate revenue from stock market transactions.

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The Securities Transaction Tax is imposed on both the buyer and the seller of securities and is calculated as a percentage of the transaction value. The rate of STT varies depending on the type of transaction and the category of securities involved. For example, different rates apply to equity delivery trades, intraday trades, futures, and options.

Capital Loss

Capital loss refers to the financial loss incurred when the selling price of a capital asset is lower than its purchase price. In simpler terms, it's the loss realised from selling an asset for less than what was paid for it. Capital assets can include stocks, bonds, real estate, mutual funds, and other investments.

Capital loss can occur for various reasons, such as a decline in the value of the asset, changes in market conditions, or poor investment decisions. When an investor sells an asset at a loss, they may be able to use that loss to offset capital gains realised from other investments, thereby reducing their overall tax liability.

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There are typically two categories of capital losses:

Short-term capital loss: This occurs when the asset is held for one year or less before being sold at a loss.

Long-term capital loss: This occurs when the asset is held for more than one year before being sold at a loss.

Capital losses can be used to offset capital gains in the same tax year. Let's say, that you sell one asset at a loss and another asset at a gain within the same tax year. You can offset the gains with the losses, resulting in a lower overall tax liability.

Additionally, if the total capital losses exceed the capital gains in a tax year, the excess losses can often be carried forward to offset gains in future years.

FAQs

Do I have to pay STT even if I incur losses while trading stocks?

Yes, Securities Transaction Tax (STT) is applicable to both profitable and loss-making transactions in stocks.

What is the duration for which capital losses can be carried forward in India?

Answer: Both short-term and long-term capital losses can be carried forward for 8 assessment years immediately following the assessment year in which the loss was first computed.

What is the threshold for exemption on long-term capital gains (LTCG)?

The exemption limit for long-term capital gains (LTCG) is Rs. 1 lakh per financial year.

Are STT and brokerage charges the same?

No, securities transaction tax (STT) and brokerage charges are not the same. STT is a tax levied on securities transactions, while brokerage charges are fees paid to brokers for their services in executing trades.

Do sellers only have to pay the STT?

No, the STT is imposed on both buyers and sellers involved in securities transactions.