Cost Inflation Index

The Cost Inflation Index (CII) is an important concept in the field of taxation in India.  As per the IT Act, CII is the measure of inflation used to adjust the cost of acquisition of an asset to calculate the capital gains tax liability. It is published by the Central Board of Direct Taxes (CBDT) annually and is based on the Consumer Price Index (CPI).

 

The CII calculates the indexed cost of acquisition of an asset, which is the actual cost of acquisition adjusted for inflation. This adjustment is made to account for the impact of inflation on the value of the asset over the years. By adjusting the cost of acquisition for inflation, the indexed cost of acquisition is higher than the actual cost of acquisition, lowering the capital gains tax liability. 

 

The concept of CII is especially useful for taxpayers who have held an asset for a long period, as the indexed acquisition cost helps reduce their tax liability. Individuals planning to sell an asset can use the CII to calculate the capital gains tax liability on the asset’s sale.

 

Overall, the Cost Inflation Index plays a significant role in India's taxation system, helping taxpayers calculate their tax liability fairly and accurately. Read on to learn more about this concept and broaden your knowledge.

The main objective of the Cost Inflation Index is to adjust the cost of acquiring an asset for inflation, and to provide an accurate capital gains tax liability. Here are a few other objectives of CII:

• Provide a fair and accurate measure of capital gains tax liability

• Account for the impact of inflation on the value of an asset over the years

• Ensure the taxpayers are not penalised for holding an asset for a long

• Lower the capital gains tax liability for taxpayers by adjusting the cost of acquisition for inflation

• Use the Consumer Price Index (CPI) as a basis for the calculation of the CII

• Provide a more equitable taxation system in India

• Encourage investment and capital gains by reducing the tax burden on the taxpayers

• Help taxpayers plan their investments and asset sales by providing a more accurate measure of tax liability

The ‘base year’ in the Cost Inflation Index refers to the year from which the index is calculated. It is the year which is used as the reference point for determining the rate of inflation in the subsequent years.

 

For example, if the base year for the CII is 2001-02, then that year's index value is considered 100. The CII values for the subsequent years are then calculated based on the rate of inflation from the base year.

 

So, if the CII for 2022-23 is 316, the cost of goods and services has increased by 216% since the base year (100+216).

 

The base year is important in the computation of the indexed cost of acquisition of an asset, which is used to calculate the capital gains tax liability.

 

The indexed cost of acquisition is calculated by adjusting the actual cost of acquisition with the help of the CII of the year of acquisition and the year of sale of the asset. The CII of the base year is used as a reference point to determine the inflation rate over the years, which helps calculate the indexed cost of acquisition.

 

Overall, the base year is an important reference point in the computation of the CII. This is used to adjust an asset’s acquisition cost for inflation and provide a more accurate measure of capital gains tax liability in India. 

The Cost Inflation Index is calculated by the Central Board of Direct Taxes (CBDT) and is based on the Consumer Price Index (CPI) for industrial workers. The CPI is the measure of change in the price of a bunch of goods and services consumed by a specified group of people. This  is used to compute the rate of inflation. 

 

The CII for a given financial year is calculated as follows:

 

CII = [(CPI for the year of calculation)/(CPI for the base year)]*100

 

Let’s take an example. Suppose you bought an apartment for Rs. 20 Lakhs in January 2000 and sold it for Rs. 35 Lakhs in January, 2009. Your capital gain/profit is Rs. 15 Lakhs (Rs. 35 Lakhs - Rs. 20 Lakhs).

 

The CII for 2000, the year you bought the apartment, is 389 (let’s assume). The CII for 2009, when the apartment was sold, is 582 (per se).

 

Then, 

The CII helps you save on taxes by adjusting the purchase price of the asset with the present market value.

The following table depicts the Cost Inflation Index of the given financial years:

In India, indexation is applied to calculate the long-term capital gains tax liability on the sale of assets such as property, equity shares, and mutual funds. Long-term capital assets are those that have been held for more than two years, whereas short-term capital assets are those which have been held for two years or less.

 

Indexation is applied to adjust the cost of acquisition of the long-term capital asset for inflation, which helps to reduce the capital gains tax liability for the taxpayers. The multiplication of the actual acquisition cost with the ratio of the cost inflation index of the year of sale and the CII of the year of acquisition calculates the indexed cost of acquisition.

 

Indexed Cost of Acquisition = Actual Cost of Acquisition * (CII of the year of sale/CII of the year of acquisition)

 

The Capital Gains Tax Liability on the sale of long-term capital assets is,

Capital gains tax liability = (Selling price - indexed cost of acquisition) applicable tax rate

 

The applicable tax rate for long-term capital gains tax in India is 20% with the benefit of indexation. 

 

For example, suppose an individual purchased a property in 2005 for Rs. 10 Lakhs and sold it 2022 for Rs. 50 Lakhs. Let us assume that the cost inflation index for 2005 is 117, and for 2022, it is 331.

 

The indexed cost would be as follows: 

 

Indexed Acquisition Cost = Rs. 10 Lakhs * (331/117)

Indexed Acquisition Cost = Rs. 28.80 Lakhs

 

The capital gains tax liability would then be as follows:

 

Capital Gains = Rs. 50 Lakhs - Rs. 28.80 Lakhs = Rs. 21.20 Lakhs

Long-term Capital Gains Tax = 20% of Rs. 21.20 Lakhs = Rs. 4.24 Lakhs

 

Applying the indexation method reduces the tax liability compared to what would have been if this method was not applied. This helps make the taxation system in India more equitable and encourages taxpayers to invest in long-term capital assets.

You must take into account the following points when computing the indexed cost of your asset’s acquisition:

• If an asset has been received at the will of an assessee, the CII is considered for the financial year when it is received. In such a case, the actual cost price of the asset should be ignored.

• Any cost of improvement which has been incurred prior to April 1, 2002, is not viable for getting indexed.

• The benefits of the indexation are not applicable to bonds or debentures other than the sovereign gold bonds issued by the RBI or the capital indexation bonds.

The Cost Inflation Index, in conclusion, is a crucial tool for calculating the capital gains tax on the sale of assets. This tool provides a transparent and fair process to help calculate the capital gains tax, which promotes the investor’s confidence and encourages investments in the economy. As such, the government’s annual revision of the CII is an important step in maintaining a stable and predictable tax regime, essential for promoting economic growth and development.