Sell shares with FIFO in mind

Having multiple demat accounts could help you save tax.

With the stock market hovering around the 20,000-mark, investors see a lot of opportunities. One could book some profits as well as get rid of underperformers and use the loss to set-off some short-term profits. If you are selling dematerialised shares of a company, you will have to follow the First In, First Out (FIFO) system.

Earlier, investors could pick and choose the shares to sell, depending on whether such shares were long-term or short-term assets. The price paid for each purchase also played a part in the tax planning exercise. For example, bonus shares, where the cost is nil (resulting in a higher profit) could be chosen to sell, along with those which would result in a substantial loss. This exercise essentially minimised the tax outgo.
 

VIKRAM’S DEMAT ACCOUNT

Date of creditParticularsQuantity 2-May-07Purchased in dematerialised form on April 30, 2007100 5-Oct-09Purchased in March 200, dematerialised later  200 25-Nov-09Purchased in dematerialised form 100

However, in the current dematerialised environment, such tax planning exercise isn't easy with respect to demateralised shares. This is due to Section 45(2A) of the Income Tax Act. It specifies that for shares sold in the demat form, the FIFO system has to be applied.

In other words, for computing capital gains chargeable to tax, the cost of acquisition and period of holding of any security shall be determined on the basis of FIFO. This means the investor no longer has the discretion to select the specific lot of the scrip to be sold -- the one dematerialised first would be deemed to have been sold first.

Lets see, how the FIFO method works if you have bought shares in the demat form first and then sent your old physical shares for dematerialisation. Taking Vikram’s case, he had purchased some HDFC shares way back in 2001 that he'd forgotten to get dematerialised. He sent these for dematerialisation only in 2009, by when he'd already purchased shares in the company in the electronic form. Consider the following table:

Let's say Vikram sells 175 shares. Under the FIFO system, the first entry of shares purchased on May 2, 2007, would be deemed to have been sold first. The next 75 shares would come out of the lot that had been dematerialised next which are the shares purchased in 2001.

The date of dematerialisation has nothing to do with the tax treatment thereof. In the first lot, though the shares were dematerialised on May 2, the date of acquisition still remains April 30, 2007. This concept becomes significant with the next entry. Note that for the next entry in the demat statement, the shares were dematerialised only on October 5, 2009. But this does not make it a short-term asset as the date of acquisition of the shares is and remains March 2001.

Also the shares purchased in 2007 and 2001 are both long-term assets. These are tax free and cannot be used to set off any losses. Ideally, Vikram would want to sell shares purchased on November 25, 2009. This would have enabled him to book short-term capital gains, and used to set off against any loss booked simultaneously. But such tax planning exercise isn't possible now.

However, since the FIFO system is applied per account individually, not collectively to all demat accounts of the investor, he can have multiple accounts. Shares of the same scrip can be credited in more than one account. For example, had Vikram owned HDFC shares purchased less than a year earlier in some other depository account, he could have chosen those to sell, even though these had been bought after 2001 and 2007, respectively.

The writer is Director, Wonderland Consultants