In the stock market, when we buy the same shares at different times and prices, the question often arises when selling them: which purchase the system recognizes first. The answer is FIFO in Demat. According to this rule, the shares purchased first are considered the first to be sold. This directly impacts your taxes, profit-loss, and investment planning. In this blog, we’ll explain this rule in simple terms and explain why it’s important for investors.
Basics of Demat and Share Transactions
What is a Demat Account?
A Demat Account allows you to hold your shares and securities in digital form. Previously, shares were available in physical certificates, but today, all shares are held electronically through depositories like NSDL and CDSL. This advantage eliminates the hassle of paperwork, transfers, and losses.
How does a share transaction work?
Whenever you buy shares, they are credited to your Demat account. Similarly, when you sell shares, they are debited from the account, and the payment is credited to your trading account/bank account.
Example : Suppose you bought 100 shares in January at ₹3,000 and another 100 shares in June at ₹3,200. Now, if you sell 100 shares, the question arises: which lot will be considered sold? This is where FIFO in Demat comes into play.
What is FIFO in Demat?
FIFO (First In, First Out) is a rule that states that when you buy shares of a company at different times and at different prices, the first shares you buy are considered when selling them. This isn’t an optional method, but rather a standard practice applicable to every investor in India.
Depositories that manage demat accounts NSDL and CDSL automatically apply this rule. This doesn’t affect the execution of your order; meaning, when you sell shares in the market, they are sold as normal. The difference is reflected only in your accounting and capital gains tax calculations.
Example
- Bought 50 shares at ₹100
- Bought 50 shares at ₹120
- Sold 50 shares
Under the FIFO rule, the system will assume you sold the first 50 shares at ₹100. This will directly impact your profit-loss and tax calculations.
Why is FIFO Important in Demat Accounts?
The FIFO rule isn’t just a technical process for investors, but a crucial part of everyday investing. It determines how share purchases and sales are recorded in your demat account and how taxes are calculated.
- Simplifies Tax Calculations : FIFO clarifies which shares are considered short-term gains and which long-term gains. This reduces the chance of error when filing income tax returns.
- Eliminates Record Confidence : When the same shares are purchased at different dates and prices, it can be difficult to keep track of them. FIFO makes it clear which shares are considered sold first.
- Same Rules Apply to Every Investor : Depositories like NSDL and CDSL apply FIFO to all demat accounts. This means that regardless of which broker you trade with, the rules remain the same.
- Transparency and Trust : If FIFO were not in place, investors could choose which lots to sell first, which could lead to tax calculation errors. FIFO prevents this arbitrariness and makes the system reliable.
- Helping Investors Prepare in Advance : People often sell shares without understanding FIFO and are later surprised by the tax implications. Knowing this rule can help you plan in advance when it’s best to sell.
Read Also: Tax Implications of Holding Securities in a Demat Account
Real-Life Example of FIFO in Action
The example below will help you understand how the FIFO rule applies:
| Date | Transaction | Quantity (Share A) | Price per Share | Total Value | Status as per FIFO |
|---|---|---|---|---|---|
| January 2023 | Bought | 100 | ₹200 | ₹20,000 | First purchased shares |
| June 2023 | Bought | 100 | ₹250 | ₹25,000 | Later purchased shares |
| February 2024 | Sold | 100 | ₹300 (assumed) | ₹30,000 | January lot of 100 shares considered sold |
Therefore, the profit will be ₹30,000 – ₹20,000 = ₹10,000.
Since the period from January 2023 to February 2024 is less than 12 months, this will be treated as short-term capital gain (STCG) and will be taxed at 20%.
FIFO vs Other Methods
Different methods are used around the world to record the purchase and sale of shares. In India, only FIFO (First In, First Out) is valid, but it’s important to understand the other methods as well.
- LIFO (Last In, First Out) : In this method, the most recently purchased shares are considered the first to be sold. If it were implemented in India, short-term gains would often be higher because recent purchases would be deducted first.
- Weighted Average : Here, the purchase price of all shares is added to arrive at an average, and profit or loss is determined based on that. It doesn’t matter which lot was purchased first or last. This method is common in many countries.
- Specific Identification : In this, the investor can choose which lot to sell. This provides flexibility, but also increases the possibility of tax evasion or fraud.
Why FIFO in India?
The Income Tax Department has mandated FIFO to ensure uniform rules apply to everyone and transparent tax calculations. This prevents investors from arbitrarily trying to evade taxes.
Impact on Investors : FIFO simplifies the process and ensures uniform rules for everyone. However, this can sometimes prove costly for traders who frequently buy and sell in short periods of time, as they have to pay higher short-term gains tax.
Read Also: Mutual Fund Taxation – How Mutual Funds Are Taxed?
How FIFO Affects Your Taxes
The FIFO rule directly impacts the tax treatment of shares and equity mutual funds.
1. Short-Term Capital Gain (STCG)
If you sell equity shares or equity mutual funds within less than 12 months, the profit is considered STCG. This has changed since July 2024 and is now taxed at 20% (previously 15%).
2. Long-Term Capital Gain (LTCG)
If shares or funds are held for more than 12 months, the gain is classified as LTCG. Since Budget 2024, LTCG is taxed at 12.5%, and does not receive indexation benefit. ₹1,25,000 exemption Long-term gains up to the first ₹1,25,000 per financial year are exempt from tax. Any gains above this limit will be taxed at 12.5%.
3. Difference due to FIFO
FIFO assumes that the oldest shares purchased are sold first. This means that even if you want to deduct new shares, tax will be calculated on the oldest shares. This can sometimes be beneficial (less tax due to LTCG being applied), and sometimes it can be detrimental (more tax due to STCG being applied).
4. ITR and Other Charges
The LTCG exemption of ₹1,25,000 under Section 112A is now clearly shown when filing ITR. A surcharge and a 4% health and education cess are also added to the tax. Capital gains are calculated after deducting brokerage, STT, and transaction charges.
Tips to Manage FIFO Impact in Your Portfolio
- Keep track of purchases and sales : Make it a habit to note the date and price every time you buy or sell shares. This will clearly show you which shares are likely to be long-term and when selling them will result in lower tax.
- Use the right tools : These days, on platforms like Zerodha Console, Pocketful, you can easily see which lot will be deducted first according to FIFO and how it will be taxed.
- Remember the 12-month limit : If a lot is about to complete 12 months, it would be wise to wait a bit. This will allow you to avoid short-term tax and take advantage of the long-term tax rate.
- Use loss harvesting : Losing shares can sometimes prove beneficial. By selling them, you can balance the FIFO gain and reduce your tax burden.
- Keep your records updated : Fast-and-fast mistakes often occur during tax filing. Having your data and transaction records clear will help prevent last-minute stress.
Conclusion
Understanding FIFO in Demat is important not only for tax purposes but also for making better investment decisions. This rule ensures that every investor’s accounting is consistent and there’s no confusion. If you understand how FIFO affects your portfolio, you’ll be able to time your investments and improve your tax planning. Ultimately, it’s wise to adopt the rule to strengthen your investment strategy.
Frequently Asked Questions (FAQs)
Can I choose which shares to sell in Demat?
No, you don’t have a choice. The system automatically applies the FIFO rule.
How does FIFO affect taxes?
It determines whether your gain is short-term or long-term, and tax will be levied accordingly.
Does FIFO apply to intraday trading?
No, it only applies to delivery shares and mutual funds.
Why is FIFO important for investors?
Because it keeps records clear and makes tax calculations easier.
