Cost Inflation Index

The cost inflation index chart is a tool used in India to calculate long-term capital gains received from capital asset transfers or sales. The profit earned from the transfer or sale of any capital asset is known as capital gain; these assets include land, stocks, property, trademarks, shares, patents and more.

Long-term assets are usually documented at their cost price, which is why even if their prices grow with time, they cannot be revalued. Thus, when these assets are sold, the profit or gain incurred from them remains high due to their higher sale price in comparison to their acquisition costs. As a result, the assesses to pay higher income tax on these assets' gains.

The application of the cost inflation index is quite beneficial in the long run, as it adjusts the purchase price of assets based on their selling price. Thus resulting in smaller earnings and lesser income tax amounts.

• The purpose of the property cost index is to adjust the tax amount resulting from the sales of long-term assets. It is well known that in accounting, whenever a long-term asset is bought, it is documented at its original price in the books of account. However, over time, the value of these assets increases due to inflation, which makes it impossible to adjust their valuation in books.

• Eventually, when these assets are transferred or sold at a higher price than their original cost value, it leads to substantial long-term capital gain. These gains lead to higher long-term capital gain tax for the assesses.

• To address this issue and ensure fair taxation, the concept of the cost index of income tax was introduced. The CII index method extends to capital gains and enables taxpayers to adjust the purchase price of their capital assets in accordance with their sale price.

• The adjustment method effectively mitigates the impact of inflation on taxable gains and allows taxpayers to present lower long-term capital gains, ultimately reducing their tax liability.

• By including the cost index in capital gains calculations, taxpayers can consider the negative impact of purchasing power over time. Moreover, this method ensures that the taxation system remains unbiased because taxation is applied to individuals and businesses based on their real gains rather than nominal ones.

• Ultimately, using the CII index in capital gains taxation aligns with just and fair economic rules, ensuring a balanced tax regime in the Indian economy.

Here is the detailed table of the cost inflation index for FY 2001-02 to the cost inflation index for FY 2024-25.

Also Read: Individual Income Tax Slab

The cost inflation index's base year is its first year and has a value of 100. The index of all the upcoming years is compared to this base year to check the inflation percentage. Moreover, if any capital asset is purchased before the base year of the cost index, the taxpayers can take the purchase value of the actual cost or the fair market value (FMV) on the first day of the base year.

Remember that the indexation benefit is applied to the purchase price of the long-term asset so calculated. FMV is based on the registered valuer's valuation report.

Reason for the Change of Base Year from 1981 to 2001

Earlier, the base year for the calculation of inflation percentage used to be FY 1981-82. However, due to this base year, taxpayers needed help to get the properties valued, which were bought before 1st April 1981. Moreover, the tax authorities were also finding it hard to rely on the valuation reports present using FY 1981-82 as the base year.

Thus, the government decided to shift the base year to 2001 so that valuations could be done swiftly and accurately. So now, for capital assets acquired before 1st April 2001, taxpayers can take the higher actual cost or FMV as of 1st April 2001 as the purchase price and get the benefits of indexation.

Indexation is a method of adjusting the cost of acquisition of a long-term capital asset for inflation to obtain the inflation-adjusted cost of the asset. Wherever an asset is sold, capital gains tax liability is determined using this modified cost. Only long-term assets or assets kept for more than 12 months are subject to indexation.

Before indexation is applied, the acquisition cost of the asset must be adjusted for any acquisition-related costs, such as legal fees or brokerage charges. Next, the result is multiplied by the cost inflation index (CII) for the year in which the asset is sold and divided by the cost inflation index (CII) for the year of asset purchase.

Here are the formulas used for the calculation of the indexed cost of acquisition and the indexed cost of improvement.

Indexed Cost of Acquisition:

Cost Inflation Index (CII) for the year of asset transfer or sale / Cost Inflation Index (CII) for the first year of the asset purchase or year 2001-02, whichever is later X Cost of acquisition

Indexed Cost of Improvement:

Cost Inflation Index (CII) for the year of asset transfer or sale / Cost Inflation Index (CII) for the year of asset improvement X Cost of improvement

Example of Indexed Cost of Acquisition

Mr A acquired a property in 2005 for ₹3,00,000 and sold it in the financial year 2023-24. Using the Cost Inflation Index (CII) value CII for the financial year 2005-06= 117 and CII for the financial year 2023-24= 348, let us calculate the indexed cost of acquisition for the property.

The indexed cost of acquisition for the property can be calculated using the following formula.

Indexed Cost of Acquisition = CII for the financial year 2023-24/ CII for the financial year 2005-06 X Cost of acquisition

Placing the given values in the formula:

Indexed Cost of Acquisition = (348/117)X 3,00,000

Answer= 8,92,307.692

So, the indexed cost of acquisition of Mr A’s property would be approximately 8,92,307.692.

Also Read: Long-Term Capital Gains (LTCG) Tax Calculation

Amendment in Finance Bill 2024

The government previously removed the indexation benefits on the sale or transfer of immovable property. However, as per the new amendment made in the 2024 bill, this rule has been removed.

As per the latest bill amendment, for any immovable property acquired before 23rd July 2024, taxpayers will be provided with the option to choose between two long-term capital gains computation methods. These methods are:

• 12.5% tax rate, without indexation

• 20% tax rate with indexation

Long-Term Capital Gain Changes

• The long-term capital gain rate on all the financial and non-financial assets has increased to 12.5%.

• The exemption on long-term capital gain has been increased from ₹1 lakh to ₹1.25 lakh per annum.

Short-Term Capital Gain Changes

• Short-term capital gain on specified financial assets will now be charged at 20%.

• Short-term capital gain on other non-financial assets will be taxed at the applicable slat rates.

• All unlisted debentures, bonds, market-linked debentures and debt mutual funds, irrespective of their holding period, will now attract tax on capital gains at the applicable rates.

Securities Transaction Tax (STT) Changes

• Securities transaction tax on future and options has now been increased to 0.02% and 0.01%, respectively.

• Any listed financial assets held for more than a year will be classified as long-term, while unlisted financial assets and all non-financial assets will now have to be held for at least two years to be classified as long-term assets.

No Indexation Benefits on Property Sales

The indexation benefits on the sales of property have been disallowed and the long-term capital gain has been reduced from 20% to 12.5%

Also Read: Long Term Capital Gain Tax on Property

• Assesses can significantly reduce their tax liabilities applicable to long-term capital gains using the cost index. They can transfer the gains acquired from assets like stocks, land, buildings, mutual funds, etc., by adjusting the total invested amount in accordance with the CII index of asset purchase and sale years.

• Let us say any capital gain incurred by an assessee from the transfer or sale of a long-term or short-term asset attracts a significant amount of capital gains taxes. Then, if the holding period of the said asset is less than 24 months, the gains incurred from a transfer of these assets are considered short-term capital gains and are not applicable for indexation.

• But remember that it applies if the holding period is less than 24 months. If the assessee holds an asset for more than 24 months during the period of transfer or sale, then they must pay tax at the rate of 20% with the CII index applicable.

• Now, when the property cost index is applied to the gains from the property, the quantum of profit is automatically reduced. As a result, the amount on which the taxes will be levied will also be reduced, which will lower the taxpayer’s tax liability on long-term capital gains.

• Reducing tax liability is a primary reason for the subsequent increase in the issuance and subscriptions of bonds and Fixed-Maturity Funds (FMF).

• Finally, the implementation of the cost index on long-term capital gains can leave taxpayers with excess amounts after they pay tax payments for long-term gains that they can use to invest in further financial instruments.

Also Read: Holding Period For Capital Gains Tax

The cost index is an important aspect of tax calculations, and knowing it is crucial to understanding how your assets are taxed. With the information provided on the cost inflation index for FY 2024-25, planning annual finances becomes easier and people can save and invest more in long-term assets.

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