Introduction

Nothing remains constant in this ever-changing world. And the same goes for money. Prices of goods and services rise over time, decreasing the purchasing power of money. The phenomenon is known as inflation. Indian laws have several provisions that help account for inflation in the economy. One such provision is the Cost Inflation Index (CII). Let's find out what CII means, how it is calculated and how it can reduce your tax liability.

What is the cost inflation index?

Defined under Section 48 of the Income Tax Act, 1961, CII is a numerical index used to assess the rise in prices of goods and services over a specific period. It is notified each year by the central government. The cost inflation index is a crucial metric in the world of investment. It is used in several financial calculations, especially those concerned with Long-Term Capital Gain (LTCG).

The cost inflation indexation table is used to ensure that the cost price of certain assets like house property, gold, etc., is adjusted for inflation. This helps calculate the real LTCG accrued from the sale or transfer of such capital assets.

Capital assets are usually documented at their cost price. The price of these assets cannot be revalued in the books despite the inflationary impact on their value. However, when eventually sold, the selling price of these assets is higher than the purchase price due to inflation. This leads to higher LTCG and therefore taxes.

This is where the capital inflation index comes in. It ensures fair taxation by helping you adjust the purchase price of these assets for inflation. A higher purchase price leads to lesser profits, which translates into lower tax liability. This is known as indexation. You can find CII in the official gazette published by the government.

Here’s the cost inflation index chart for assessing LTCG :

How is CII calculated?

When you apply the indexation benefit to an asset’s cost price, it is known as Indexed Cost of Acquisition or ICOA. Here’s the formula to calculate ICOA

ICOA = Cost of acquisition * (CII of the year of asset sale or transfer/CII of the year of the asset purchase)

Now, let's consider an example.

Mr. Sanjay purchased a house property for INR 5,00,000 in the year 2007-2008. He sold it in the year 2017-2018 for INR 30,00,000. The profit he earned was INR 25,00,000. However, factoring inflation into the asset’s cost price is essential. So, we need to calculate the Indexed Cost of the Acquisition of the house property. Here’s how you can do it:

First, consider the CII for the years of asset purchase and asset sale from the indexation chart:

CII in 2007-2008 = 129

CII in 2017-2018 = 272

ICOA = Cost of acquisition * (CII of the year of asset sale or transfer/CII of the year of the asset purchase)

= INR 5,00,000 * (272/129) = INR 10,54,264

Mr. Sanjay's LTCG on selling the asset will be as follows:

LTCG = Selling price of the asset-ICOA

= INR 30,00,000 - INR 10,54,264

= INR 19,45,736

Hence, the LTCG of Mr. Sanjay is INR 19,45,736 instead of INR 25,00,000 due to the inflation-adjusted price of the asset. He will now have to pay tax on INR 19,45,736.

Things to remember

Here are a few things to remember before capital inflation index calculation:​​​​​​​

• If you have received an asset or a property in a will, consider indexation rates for the year of receiving the asset instead of the year when it was purchased
• Indexation benefit does not apply to bonds or debentures except sovereign gold bonds issued by the Reserve Bank of India (RBI) and capital indexation bonds
• The indexation benefit does not apply to debt funds from April 1, 2023
• Improvement costs incurred before April 1, 2001, are ignored

Wrapping up

Using the index cost chart in your tax calculations can reflect the impact of inflation on your investment and significantly lower your tax liability. Thus, CII ensures a fair and transparent system of taxation.

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