Cost Inflation Index - Meaning, Calculation & Benefits

 Inflation is an economic term and referred to the continuous rise in the price of goods and services, thereby reducing the purchasing power of the money. The pinch of inflation is felt by all sections of the economy, be it, the consumers, investors, and the government.  And, even though it increases the cost of living, inflation is a necessary evil and desirable for the growth and development of the economy.

For the reason of inflation, it is only fair to pay more for your goods like comb and brush over the years due to an increase in the price. For the same reason, it is unfair to pay capital gains tax on your assets without taking into account the impact of inflation on the value of the asset. Cost Inflation Index(CII) is the index to calculate the increase in the price of assets year-on-year due to the impact of inflation.

What is the Cost Inflation Index?

Cost Inflation Index or CII is an essential tool for determining the increase in the price of an asset on account of inflation and is useful at the time of calculating the long-term capital gains on the sale of capital assets. It is fixed by the central government and released in its gazetted offices by the Ministry of Finance every year.

Capital gains are the profits arising from the sale of assets like real estate, financial investment, jewellery, etc. The cost price of the asset is adjusted taking into account the Cost Inflation Index of the year of purchase and the year in which the asset is sold, and the entire process is known as Indexation.

Cost Inflation Index Calculation

The cost inflation index calculation is done by the government to match the inflation rate for the year and calculated using the Consumer Price Index (CPI).

Cost Inflation Index India for the financial year 2019-20 has been set at 289.

Change of the base year for the Cost Inflation Index

The cost inflation index base year was changed in the Union Budget 2017 from 1881 to 2001. The base year was changed by the government to enable accurate and faster calculations of the properties purchased before April 1, 1981, as taxpayers started to face problems with valuations of older properties.

The base year has an index value of 100, and the index of the following years is compared to the index value in the base year to determine the increase in inflation.

With the change in the base year, the capital gains and tax burden has reduced significantly for the taxpayers as it now reflects the inflated price of the asset realistically.

The current Cost Inflation Index Chart for each year is as under-

How is the Cost Inflation Index (CII) used in calculating capital gains

To calculate the capital gains on your assets the purchase price of the asset is indexed by the cost Inflation Index using the formula below-

Indexed cost of the asset at the time of acquisition =

(CII for the year of sale/ CII for the year of purchase or base year (whichever is later))*actual cost of acquisition

If suppose you purchased a flat in December 2010 for Rs 42 lacs and sold in Jan 2019 for Rs 85 lacs. Your capital gain from the sale of the flat is Rs 43 lacs.

The CII in the year in which the flat was purchased is 148, and the CII in the year the flat was sold in is 280.

The purchase price of the flat after taking into account the Cost Inflation Index is =

(280/148)*Rs42 lacs= Rs 79. 46 lacs

 This is the indexed cost of acquisition.

Your long-term capital gain after taking indexation into account is Rs 85,00,000- Rs 79,45,946 = Rs.5,54,054.

Long-term capital gains on the sale of property are taxed at 20% with indexation benefit. So, your tax liability, in this case, would be-

20% of Rs 5, 54, 054= Rs 1,10,810

Without indexation benefit, the capital gains are taxed at 10%. In this case, the capital gains would be-

Sale price of the flat - purchase price of the flat = Rs 85,00,000 – Rs42,00,000 = Rs.43,00,000.

 The capital gains tax without indexation benefit will be 10% X Rs 43,00,000 = Rs.4,30,000.

Thus, indexation helps reduce the long-term capital gains and reduce the overall tax burden for the taxpayer considerably.

Indexation benefit can be used for investments in mutual funds, real estate, gold, FMPs, etc. but is not applied for fixed income instruments like FDs, recurring deposits, NSC, etc.

Few important tips to remember about the Cost Inflation Index-

• If you receive an asset as a part of the will, then in such the CCI for the year in which it was transferred will be considered and not the CCI of the purchase of the asset
• Indexation benefit for the cost of improvement of the asset is the same as the cost of improvement of the asset.
• Cost of improvement incurred before 1981 to be ignored.

CONCLUSION

Cost Inflation Index is an important parameter to be considered at the time of selling long-term assets as it is beneficial for the investors. Reach out to our experts at IndiaNivesh for any queries about capital gains arising from the sale of assets for correct guidance.

 

Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

Ref: https://www.indianivesh.in/kb-blog/cost-inflation-index