The Cost Inflation Index uses the CPI calculate the inflation in order to determine the long-term capital gains earned from the sale of an asset. The calculation of inflation helps reduce the amount of tax payable on long-term capital gains.
The value of rupee today will not stay the same for tomorrow. The prices keep increasing due to inflation. It is fair to pay more for toothbrush over the years because of the price rise. Likewise, it is not fair to pay Capital Gain Tax without incorporating the factor of inflation.
Capital gains is the profit you make on selling an asset. It can be real estate, stock, mutual funds, jewellery etc. If you are selling the asset after 36 months from the date of purchase, it becomes a long term capital gain. If you are selling an asset after one year from the date of its purchase, the profit becomes a short term capital gain. The government charges tax on our sale of the asset and they do not wish to let go of the capital gain. Hence, the government charges capital gains tax. Cost inflation index India is an index issued by the Central Board of Direct Taxes and the figures keep changing every financial year.
What is cost inflation index?
The cost inflation index (CII) is a means to measure inflation, which is used in the computation of long-term capital gains with regard to the sale of assets. Cost inflation takes into account the Consumer Price Index (CPI) for a given year for urban non-manual employees for the preceding year. As the price of a capital asset is likely to rise in the years between the purchase and its sale, selling the asset would net the owner a significant amount.
Since the government levies a tax on such transactions, the owner would be required to pay a hefty sum as tax. In order to avoid paying a large sum towards tax, the sale price of the asset can be indexed to demonstrate the asset’s value as per its current value, taking into account inflation reducing its value. In this manner, the profit derived from the sale would be lower, thus reducing the capital gains payable.
Thus, indexation helps reflect the actual value of the asset at present market rates, taking into account the erosion of value due to inflation.
When selling an asset, the purchase price is referred to as the indexed cost of acquisition. The cost inflation index (CII), therefore, is the indexed price that the asset is purchased at. The CII for a particular year is fixed by the government and released before the accounting year ends, for the purpose of tax computation.
New cost inflation index for the Financial Years
The new cost inflation index (CII) for the year FY 2020-21 is 301.
Old Cost Inflation Index Chart
Old Cost Inflation Index for the last ten financial years as follows:
|Financial Year||Index||Financial Year||Index|
Calculate Cost Inflation Index
The purchase price of the asset is indexed by the cost inflation index.
The formula to calculate the cost inflation index is as follows:
Cost Inflation Index (CII) = CII for the year the asset was transferred or sold / CII for the year the asset was acquired or bought
Suppose, you purchased an apartment for Rs.20 lakhs in Jan 2000 and sold it for Rs.35 lakhs in Jan 2009. Your profit or capital gain is Rs.15 lakhs.
The CII for the year the apartment was bought in is 389. The CII for the year the apartment was sold in is 582.
The cost inflation index is 582/389 = 1.49
While computing tax, CII is multiplied with the purchase price to arrive at the indexed cost of acquisition. This is the actual cost of the asset.
Therefore, the indexed cost of acquisition = 20,00,000 X 1.49 = Rs.29,92,288
The long term capital gain= sale value of the asset- indexed cost of acquisition i.e., 35,00,00- 29,92,288 = Rs.5,07,712
The tax liability if you use the indexation method is charged at 20 percent. The tax liability will be 20% X 5,07,712 = Rs.1,01,542
If you do not use the indexation method, the tax is liable at 10% on the capital gain. The capital in this case is sale price of the apartment – cost of acquisition = 35,00,000 – 20,00,000 = Rs.15,00,000. The capital gains tax is 10% X 15,00,000 = Rs.1,50,000.
When you index, it helps you save taxes. It helps you adjust the purchasing price of the apartment with the current market prices.
How is CII Useful in Reducing Tax?
We saw in the earlier example that indexing helps us save a substantial amount of Income Tax that will be levied on the long term capital gain arising out of selling off your asset. But, indexation is not available for short term capital gain or losses. This benefit is also not available to Non-Resident Indians.
The indexation for long term capital gain is available only if you meet the following criteria:
- Cost of acquisition of the asset has to be multiplied with the cost of inflation of the year it was transferred.
- That figure is to be divided by the cost inflation index for the year in which the asset was acquired.
- If the asset was purchased before 1981, the cost inflation index of the year 1981 must be taken into consideration.
- If you have made improvement of the asset, then you need to adjust the cost inflation index with the multiplying with the CII of the year the improvement was made.