Important Keyword: CII, Cost Inflation Index, Indexation, Long Term Capital Gain.

Cost Inflation Index: CII Income Tax

Inflation is a phenomenon characterized by the gradual increase in prices, leading to a decrease in the purchasing power of money. For taxpayers, it’s crucial to account for inflation when calculating capital gains tax, as it affects the cost of goods or services each year.

To mitigate the impact of inflation on capital gains tax, taxpayers can leverage the concept of indexation. Indexation involves adjusting the cost of acquisition by incorporating the effect of inflation, resulting in what is known as the indexed cost. This indexed cost reflects the actual purchasing power of the money invested, considering the rise in prices over time.

The key tool used in indexation is the Cost Inflation Index (CII), which helps estimate the increase in prices each year due to inflation. The Income Tax Department notifies the CII for each financial year, providing taxpayers with the necessary information to calculate indexed costs accurately.

The Cost Inflation Index (CII) plays a crucial role in computing the cost of acquisition or improvement while factoring in the impact of inflation over the years. Here’s a simplified explanation of what CII entails and how it affects tax calculations:

Meaning of Cost Inflation Index (CII): The CII is an index used to adjust the cost of acquisition or improvement of assets, considering the effect of inflation over various financial years. It helps taxpayers determine the real purchasing power of their investments by accounting for changes in prices over time.

Calculation of CII:

The CII is computed based on 75% of the average rise in the Consumer Price Index (CPI) for the immediately preceding year. The CPI measures the increase in prices by comparing the current cost of a basket of goods and services with the cost of the same basket in the previous year.

Publication of CII:

The Central Government publishes the CII in the official gazette, providing taxpayers with the necessary index values for each financial year. For example, the Cost Inflation Index for the financial year 2022-23 (Assessment Year 2023-24) is 331, as per the CBDT Notification dated 14th June 2022.

Cost Inflation Index Chart:

The Income Tax Department maintains a list of the Cost Inflation Index (CII) on its website, offering taxpayers easy access to the index values for different financial years.

The base year is a crucial element in the Cost Inflation Index (CII) as it serves as the reference point for comparing index values across different financial years. Here’s an explanation of the significance of the base year and the recent change in the base year of the CII:

Base Year in Cost Inflation Index:

The base year is the initial year of the Cost Inflation Index, assigned an index value of 100. All subsequent financial years’ CII values are compared to the base year to calculate the percentage increase in inflation. This comparison helps taxpayers adjust the cost of acquisition or improvement of assets to reflect changes in prices over time.

Impact of Base Year on Taxation:

For taxpayers who purchased capital assets before the base year, determining the cost of acquisition can be challenging. In such cases, they can use either the actual purchase price or the Fair Market Value (FMV) on the first day of the base year. The CII of the base year is then used to calculate indexation on this cost of acquisition.

Change in Base Year:

Prior to the Finance Act 2017, the base year for the CII was 1981-82. However, taxpayers faced difficulties in obtaining property valuations for assets purchased before April 1, 1981, and tax authorities were hesitant to rely on valuation reports. To address these issues, the government shifted the base year to 2001-02 under the Finance Act 2017. This change aimed to simplify and enhance the accuracy of property valuations for taxation purposes.

How to calculate Long-Term Capital Gains with Indexation benefits?

Below is the calculation of Long Term Capital Gains with the benefit of indexation.

How to calculate the Indexed Cost of Acquisition and Indexed Cost of Improvement?

Calculating Long-Term Capital Gains with Indexed Cost of Acquisition

To compute Long-Term Capital Gains (LTCG), one needs to factor in the Indexed Cost of Acquisition and the Indexed Cost of Improvement, if applicable. Here’s how to calculate these values:

Indexed Cost of Acquisition:

To calculate the Indexed Cost of Acquisition, use the formula: Indexed Cost of Acquisition = Cost of Acquisition * (CII for the year of sale / CII for the year of purchase)

Example 1:

Mr. A purchased a flat in FY 2018-19 for INR 50,00,000. He sells the flat in FY 2021-22 for INR 80,00,000. CII for 2018-19 = 280 CII for 2021-22 = 317 Indexed Cost of Acquisition = 50,00,000 * (317/280) = INR 56,60,714

Example 2:

Mr. B purchased a property in FY 1994-95 for INR 30,00,000. He sells the same in FY 2014-15 for INR 1,30,00,000. The FMV of the property on 1st April 2001 was INR 50,00,000. CII for 2014-15 = 240 CII for 2001-02 = 100 Cost of Acquisition (using FMV as on 1.4.2001) = INR 50,00,000 Indexed Cost of Acquisition = 50,00,000 * (240/100) = INR 1,20,00,000

Indexed Cost of Improvement:

If there are any improvements made to the property, the Indexed Cost of Improvement is calculated similarly.

Once the Indexed Cost of Acquisition and Indexed Cost of Improvement are determined, one can calculate the LTCG by subtracting the indexed acquisition cost from the selling price of the property. In both examples, the LTCG would be the selling price minus the respective indexed acquisition costs.

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Official Income Tax Return filing website: https://incometaxindia.gov.in/