Updated on: 19.06.2022.
Cost Inflation Index number is referred to while calculating the Indexed cost of acquisition of a capital asset, which further helps in calculation of the long-term capital gains tax.
The complete process is called as Indexation, where the cost price of a capital asset is adjusted with the impact of Inflation using the cost Inflation Index number, which is announced by the Central government every financial year.
This post is to explain the indexation process and how does cost inflation index number helps in calculate long-term capital gains tax. Since this is a bit technical thing, but I have tried to simplify it the maximum I can. If you still have some doubt, please feel free to write in the comments section below the post.
What is Cost Inflation Index / Capital gain Index?
Cost Inflation Index or as some people call it Capital gain Index is announced by the central government for every financial year, after referring to the CPI (Consumer Price Index) for the immediately preceding year. In simple language, Cost Inflation index factors in the change of inflation in capital assets year on year.
While calculating long-term Capital gains tax government has allowed adjusting the cost price of the capital asset with the inflation numbers through Cost Inflation Index, and come up with the Indexed cost of acquisition of that capital asset.
Now to calculate the actual gain, one has to deduct the indexed cost of acquisition rather than the original cost of the asset to come out with the Profit number.
Let’s understand this, as an example:
You bought a piece of Land in the year 2010 for Rs 10 lakh and sold the same for Rs 25 lakh in 2017. Now in the simple calculation, you made a gain of Rs 15 Lakh (25-10). But from taxation angle you are allowed to adjust Inflation to your Purchase price, through Cost Inflation index numbers, to come up with the Indexed cost of acquisition and real taxable gain.
Read on to find out how to use cost inflation index to calculate Indexed cost of acquisition
Some related terms and definitions:
Capital asset – The Capital assets have been defined in section 2(14) of Income tax act. But from Investors’ understanding in simple term, all Investments that does not generate a fixed rate of return on your money are termed as a Capital asset. Gold (In any form), Real estate, Debt securities and Equity Investments all come under capital assets definition.
Indexed cost of acquisition – This is the term used for the purchase cost arrived at after adjusting the cost inflation index numbers.
Capital gains – The profit arrived at after selling the capital asset is called as Capital gains. It is further divided into 2 parts – Short-term capital gains and Long term capital gains.
The Type of capital assets and your holding period of that asset before selling it define the short and long-term nature of the capital gains.
Sticking to this article, Capital gain Index is used only in case of Long-term capital gains calculation and that too in non Equity asset classes like Gold, Real estate (residential/commercial/land), tradeable debt securities. (Read: Taxation of Mutual funds in India)
The minimum holding period required to qualify a non-equity capital asset for the long term is 3 years. And Specifically for Real estate is 2 years.
Referring to the real estate example above, since the holding period of land was 7 years, so it came into the category of long-term capital asset. If it was less than 2 years, then it would have been called as Short-term capital asset
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Cost Inflation Index table or Indexation table
The Indexation table used to have a base year of FY 1981-82, which means that any property bought after 1981 has an index number to calculate the Indexed cost of acquisition. But if a property was bought before 1981, then a government approved valuer has to come into the picture and help to calculate the fair market value of the property.
From FY 2017-18, the base year of cost inflation index has been changed to 2001. This means that if the capital asset was bought before 2001 then the Fair market value has to be calculated as on 2001-02, and after that, the number can be adjusted with cost inflation index.
Below is the cost inflation index table with data till FY 2021-22
|Financial year||CII||Financial Year||CII|
The Cost Inflation Index for FY 2022-23 (AY 2023-24) is 331.
How to calculate the Indexed cost of acquisition?
Let’s understand this, as an example:
Purchase date of Property/Gold/Debt Mutual fund: 1st May 2004 (FY 2004-05)
Purchase price: Rs 10 lakh
Sale Date: 9th November 2017 (FY 2017-18)
Sale Price: Rs 25 lakh
Indexed cost of acquisition: (Purchase cost/CII of the year of purchase)*CII of the year of sale
Applying the formula in the example, the indexed cost of acquisition comes out to be
(1000000/113)*272 = Rs 24,07,079/-
This is the cost which is to be used to calculate the Capital gain and tax on the profit made.
How to calculate Long-term capital gains tax with capital gain index
After knowing the Indexed cost of acquisition on applying the cost inflation index, it is now easy to calculate the Capital gain and Tax on the same.
You just have to deduct the Indexed cost of acquisition from the Sale price.
In the above example, the sale price was Rs 25 lakh and our calculated Indexed cost of acquisition was Rs 24,07,079, so the capital gain, in this case, is Rs 92921/- ( Rs 25 lakh-Rs 24.07 lakh)
Rs 92921/- is the Indexed gain on which your long-term capital gain tax will be calculated
Cost inflation index is used to calculate the Indexed cost of acquisition which further helps in coming with the capital gains taxation. This calculation applies to all capital assets except Listed Equity shares (for Stock market transactions) and Equity Mutual funds.
Hope you are clear on the Concept of Cost Inflation Index. In case you have any question, feel free to ask in the comments section below.