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Cost Inflation Index

Last Update Date : October 01, 2018

Inflation is usually painful when you are the buyer, but it is equally pleasant when you are the seller as you are about to make gains of the asset that you owned. The concept of inflation is therefore very important in computing the tax liability on the capital gains. The Cost Inflation Index is used for computing the gains and taxes on the capital assets.

Cost Inflation Index

Cost Inflation Index is an index which depicts the impact of inflation in the prices of the Capital Assets. It is a method which is used to compute the real gains by the sale of an asset with the effect of inflation. CII is calculated by the Government of India and Central Board of Direct Taxes (CBDT) using the Consumer Price Index (CPI) for a given year and discloses the index before the Financial Year ending. This Cost Inflation Index is then used for computation of Capital Gains and related Taxes. If the index is not used, the inflated prices increase your gains and more gains results into more tax payable amount. Therefore, use of cost inflation index is beneficial for a taxpayer. Thus, the cost inflation index describes the present market value of an asset which has increased due to inflation.

Important terms related to Cost Inflation Index

Capital Assets and Capital Gains

It is an asset like movable and immovable property, equity shares etc. which on sale produces gains or loss. The gains on the capital assets are known as capital gains.

Depending on the holding period capital Assets are further classified into Short-term capital assets and Long-term capital assets. In general, the assets which are held for less than three years are termed short-term capital assets and the assets which are held for more than 3 years are termed as long-term assets. The gains produced on these assets are then categorised as short-term capital gains and long-term capital gains respectively. Immovable property and equity shares held for more than 2 years are treated as long term.

Indexed cost of acquisition

The value of purchase cost at the time of sale of an asset which is re-computed using the cost inflation index is known as the indexed cost of acquisition. It simply means adjusting the original cost with the rate of inflation.

Indexed cost of improvement

Whenever an asset especially house property is being reconstructed or renovated, the cost incurred on such improvements is treated as a cost of the improvement. This cost is further indexed as per the cost inflation index to arrive at the indexed cost of the improvement.

Cost Inflation Index for Different Years

The following table represents the value of Cost Inflation Index from the base year 2001-02. The Cost Inflation Index Value in the next financial year depends on the amount of inflation the country faces in the year.

Financial Year Cost Inflation Index Financial Year Cost Inflation Index
2001-02 100 2010-11 167
2002-03 105 2011-12 184
2003-04 109 2012-13 200
2004-05 113 2013-14 220
2005-06 117 2014-15 240
2006-07 122 2015-16 254
2007-08 129 2016-17 264
2008-09 137 2017-18 272
2009-10 148

Calculation of Cost Inflation Index

The formula gives the cost inflation index

CII = CII for the year of sale of the asset/ CII for the year of purchase of that asset.

Example: If a capital asset were purchased in the year 2007-08 and sold in the year 2011-12, the cost inflation index factor for the capital asset would be:

= CII for the year 2011-12 / CII for the year 2007-08
= 184/129
= 1.43

Therefore, if the purchase price in the year 2007-08 is Rs. 100, the CII signifies that the purchase price of the same asset in the year 2011-12 is Rs 100 x 1.43 which is Rs 143

Computation of Capital Gains using Cost Inflation Index

Indexed Cost of Acquisition

The formula calculates indexed Cost of Acquisition

Purchase price of the asset in the year of purchase x (CII for the year of sale of the asset/ CII for the year of purchase of that asset)

Indexed Cost of Improvement

Indexed Cost of Improvement is calculated by the formula

Improvement cost of the asset in the year of improvement x (CII for the year of sale of the asset/ CII for the year of improvement)

Capital Gain on an asset

The formula calculates capital Gain on the asset

Capital gain = Net selling price of the asset – (indexed cost of acquisition + indexed cost of improvement)

Calculation of Capital Gains – Various Scenarios

Consider the following example for computation of capital gains

Description Value
Year of purchase of property 2007-08
The purchase price of the property Rs 1,00,000
Year of improvement of the property 2012-13
Cost of improvement Rs 50,000
Year of the sale of the property 2015-16
The selling price of the property Rs 6,50,000
CII for 2007-08 129
CII for 2012-13 200
CII for 2015-16 254

Calculations

Scenario 1: When the individual himself does the purchase and sale:

Indexed cost of acquisition = 1,00,000 x (254/129) = Rs 1,96,899
Indexed cost of improvement = 50,000 x (254/200) = Rs 63,500
Capital Gains = 6,50,000 – (1,96,899 + 63500) = 6,50,000 – 2,60,399 = Rs 3,89,601

Scenario 2: When the purchase and sale are done other than the original owner:

If the property is transfer from one person (under gift, will or inheritance) to the other, the computation of gains will be same, but the gains will be received by the new owner and not the original owner.

Indexed cost of acquisition = 1,00,000 x (254/129) = Rs 1,96,899
Indexed cost of improvement = 50,000 x (254/200) = Rs 63,500
Capital Gains = 6,50,000 – (1,96,899 + 63500) = 6,50,000 – 2,60,399 = Rs 3,89,601

Scenario 3: When the purchase is before 2001-02 and sale is done on or after 1st April 2001

When the purchase of an asset is before the base year, the purchase price of the asset is taken as the fair market value of the asset in that base year and the CII for purchase year is taken as CII for the base year. In the above example, let us assume that the fair market value of the property in 2001-02 is Rs 2,00,000.

Indexed cost of acquisition = 2,00,000 x (254/100) = Rs 5,08,000
Indexed cost of improvement = 50,000 x (254/200) = Rs 63,500
Capital Gains = 6,50,000 – (5,08,000 + 63500) = 6,50,000 – 5,71,500 = Rs 78,500

Tax on Capital Gain

  1. If the sale of the asset takes place within two years w.e.f. F.Y. 2017-18 from the year of purchase, the gain earned on the asset is a short-term capital gain. It will be taxed according to the tax slabs under which the individual falls.
  2. If the sale of the asset (immovable property and shares) takes place after two years w.e.f. F.Y. 2017-18 from the year of purchase; the gain earned on the asset is a long-term capital gain.
    Example: If the capital gains without indexation is Rs 5,00,000 and with indexation is Rs. 1,50,000. Therefore the tax levied will be Rs 50,000 (10% of 5,00,000) without indexation and Rs 30,000 (20% of 1,50,000) with indexation respectively.

Use of Cost Inflation Index in the reduction of tax

Cost Inflation Index increases the purchase price, thereby reducing your capital gains. Reduction in capital gains reduces the amount of tax payable on the same. Also, the inclusion of the cost of improvement will further reduce the capital gains resulting in less tax liability.

The method of indexation using the cost inflation index is very beneficial if you want to reduce the tax on capital gains. Contact our tax experts to advise you in saving your capital gains taxes.

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