The introduction of Demat in 1996 by the Securities and Exchange Board of India (SEBI) has revolutionized the Indian capital markets. Before this, investments and trading activities took place by transferring physical certificates of securities in the ring at BSE
Nowadays, it is mandatory to have a demat account to invest or trade in the numerous financial offerings available to an individual. Demat, unlike the common misconception, does not hold shares only. It can be used for holding various other financial instruments like bonds, Exchange-traded funds (ETFs), government securities, corporate bonds, mutual funds, and insurance policies. As per the latest data available from NSE and BSE, 99.9% of transactions are in dematerialized mode only.
In this article, we will discuss what a demat is, why you should convert from physical to demat, its security, how to dematerialize physical shares, and finally, the tax implications for the dematerialization of shares.
What is a Demat?
Dematerialization (demat) is the conversion of physical certificates into electronic balances. Here physical certificates in circulation are retired in exchange for an electronic record. The depository participants issued this electronic certificate (demat) with a unique number for each account, making it extremely safe. Currently, there are two licensed depository participants in India:
- NSDL (National Securities Depository Ltd)
- CSDL (Central Securities Depository Ltd)
A Demat account enables investors to hold shares and securities electronically. Unlike its predecessor, this facilitates the quick and easy transfer and reception of shares. The physical certificates are cumbersome to store and transfer. Not only has it eliminated unnecessary paperwork, but it has also helped streamline the process of share trading.
Why should you convert from physical to demat shares?
Dematerialization of shares has various benefits, some of which have been elaborated on below:
1. Fewer risks: Physical shares are subject to loss, damage, and theft risks. It is also susceptible to fraud and manipulation by unscrupulous persons. With a demat account, investors can store all their investments or shares in a safe and secure digital depository.
2. Convenient storage: Keeping tabs on all physical shares and their performance is tedious and time-consuming, especially if the investor holds a large volume of shares. A demat account empowers the investor to easily access and monitor its holdings and relative performance.
3. Reduced transaction costs: Dealing in physical shares involves additional charges that are difficult to determine in advance. These additional costs may be handling expenses, stamp duty, and other similar outlays. Whereas in the demat account, the only charge payable is the brokerage charge, which is informed in advance.
4. Reduced transaction time: Transacting with physical shares involves sending shares to the company or the registrar to get the shares transferred in the investor’s name. This is a lengthy process, sometimes taking months to get the shares transferred. With a demat account, all the investor needs is a delivery instruction slip (DIS) to transfer their securities, which occurs almost instantaneously. Additionally, dematerialization mitigates the risk of inefficiencies such as delayed settlements and transactions, thus ensuring swift transactions.
5. No odd lot problems: Before demat accounts, investors could not buy or sell shares in odd lots. The introduction of demat accounts has removed such inconvenience, allowing investors to trade in odd lots and even buy or sell a single share.
6. Nomination facility: A demat account provides nomination facilities to investors as per the process described by the depository. This will allow investors to appoint a nominee to operate their accounts in their absence.
7. Loan collateral: Investors can pledge their demat accounts’ securities to secure a loan against securities. The shares held, liquidity, and acceptability will help investors procure loans at low-interest rates.
8. Corporate activities: If a company held by the investor declares a dividend, the benefits are automatically credited to the beneficiary’s demat account. In addition to this, corporate actions like stock split, bonus issue, or right shares are automatically updated in the demat account of all the company’s shareholders.
9. No TDS: The Central Board of Direct Taxes (CBDT) has granted dispensation from tax deducted at source (TDS) when demat accounts make payments. This also means that no TDS is deducted from the interest received by investors on bonds and securities.
10. Easy accessibility: A demat account is easily accessible through multiple platforms. This includes devices like smartphones, computers, or any other smart devices.
Are demat accounts safe and secure?
Demat accounts are held by depository participants on behalf of either the NSDL or the CSDL, making them the safe custodians of demat accounts. They are held as per the SEBI’s regulations. This makes fraud less likely to occur due to the standardizing PoA (power of attorney) norms under SEBI’s regulations. The SEBI has mandated a strict and limited purpose of PoA and has restricted the broker’s right to administer the transfer of securities and funds for settlement purposes only.
Brokers could not execute transactions or transfer securities for off-market trades without the written consent of the account holder. Also, the electronic format of trade transactions and settlements ensures a trail for the authorities to track, discouraging any fraudulent and illegal activities among market participants.
All these features and restrictions in place make demat accounts highly safe. Additionally, investors should adhere to the following guidelines to keep their demat accounts safe.
- Keep their credentials, i.e., username, password, and the related security question and answer confidentially.
- Ensure that their email address and mobile number are regularly updated with the depository participant.
- Keep an eye on any SMS and email alerts.
- Regularly check the holdings statement to ensure that the statement is reflected correctly.
- Freeze their account immediately if any fraudulent activity is observed and bring it to the attention of the concerned authority.
How to dematerialize physical shares?
The Securities and Exchange Board of India (SEBI) has recently amended its provisions to disallow listed companies from accepting requests to transfer physical shares with effect from April 1, 2019. This means that investors must convert their physical shares to dematerialized (demat) form if they wish to transfer or trade them.
Investors can dematerialize shares for those companies traded in the stock exchanges or listed in the depositories. The step-by-step process to convert physical shares into demat form is given below:
1. Open a demat account.
- Choose a depository participant – a stockbroker who links an investor with a depositor – of your preference.
- Submit all the necessary Know Your Customer (KYC) documents. These typically include proof of identity, proof of residence, a photo, and an account opening form.
- Nowadays, several depository participants allow the online opening of demat accounts by uploading scanned copies of KYC documents.
2. Request for dematerialization of shares.
- Once the demat account is opened, contact your depository participant for a Dematerialization Request Form (DRF).
- Fill up the DRF and sign it. Use separate forms for shares of different companies.
- Submit the filled form and the physical shares’ certificates to your depository participant. It is crucial that “Surrendered for Dematerialization” is written on each paper shares certificate.
- After this process, your depository participant will send the dematerialization request to the concerned company’s Registrar and Transfer Agent (RTA).
- Once the decentralization process is approved, your physical certificates will be destroyed. Your demat account will be credited with the relevant number of shares.
- This completes the dematerialization process.
The entire dematerialization process usually takes 2 to 3 weeks to complete. Also, a standard fee of Rs. 150-400 per share certificate is charged for the conversion process. The fees charged varies according to the depository participants.
Tax implications for the dematerialization of shares.
Under the Income Tax Act 1961, the following tax implications fall on an investor’s demat account.
- Tax on Short-term capital gain (STCG)
If an asset is held for 12 months or less, it is a short-term capital asset. If an investor gains by selling such an asset, then the generated gain is STCG. If applicable, investors are liable to pay a 15% Securities and Transaction Tax (STT) on the gain. If the STT doesn’t apply, the STCG is added to the investor’s total taxable income and is taxed according to the investor’s income tax slab.
- Tax on Short-term capital loss (STCL)
If an investor incurs a capital loss on a short-term capital asset, it is STCL. An investor can offset the STCL in the same financial year, as per the Income Tax Regulations. Suppose the investor is unable to offset these losses in the same financial year. There is a provision allowing the investor to carry forward the loss for a maximum of eight financial years.
- Tax on Long-term capital gain (LTCG)
When an asset is held for more than 12 months, it is termed a long-term capital asset. If an investor profits by selling such an asset, the gain made is LTCG. Investors are liable to pay a tax of 10% on their LTCG with an exemption up to Rs. 1 lakh for the given financial year.
- Tax on Long-term capital loss (LTCL)
If an investor loses while selling a long-term capital asset, the loss can be offset against the LTCG for up to eight years. However, LTCL can only be used to offset against LTCG made during the financial year.
Dematerialization has ushered in a new era of electronic trading. This has led to the growth of trading activities among the general public. A demat account is a significant improvement over the past physical shares trading. It provides many previously unavailable features, making investing safer, easy, and accessible by the general mass. Proper research must be conducted to understand the varied offerings of the various depository participants to decide and choose accordingly. Investors must exercise caution to ensure that their demat account’s credentials don’t fall into the wrong hands.
RURASH is amongst the best Indian investment management firm, providing financial solutions to augment the client’s wealth and facilitate building a legacy.