What is Cost Inflation Index? Details about Indexation in Income Tax

We can all agree that the economy is fickle and dynamic. The value of goods continuously increases, which leads to a decrease in the purchasing power of the money. Due to inflation, if you could buy 10 chocolates for ₹100 yesterday, you can now, only buy 5 chocolates for that amount. However, it’s also possible to predict how the price of a product would change during the year. You can estimate how an asset's value would increase with the Cost Inflation Index (CII).

The central government calculates and publishes this index value in the official gazette to gauge inflation. With Cost Inflation Index India, you can match the prices of an asset to the inflation rate. Let's take a deep dive into Section 48 and understand Cost Index Inflation income tax.

What is the Cost Inflation Index?

The Cost Inflation Index chart is a tool used to calculate the notional increase in the value of an asset due to inflation. It helps you adjust the cost price of a capital asset as per the rate of inflation. Basically, you can calculate long-term capital gains earned by selling or transferring capital assets with Cost Inflation Index India. Capital gains are profits accrued from the sale or transfer of assets like land, property, stocks, shares, trademarks, patents, etc.

Cost Inflation Index Applicability in Income Tax

Increasing inflation does not lead to the revaluation of a long-term capital asset. It is always recorded at cost price in the books of accounts. The sale value of these assets remains high as compared to the purchase price. Hence, this leads to higher income tax. The Cost Inflation Index is applied to long-term capital assets to increase the purchase cost. Consequently, it results in lesser profits and tax deductions for the assessee.

What is the Current Cost Inflation Index?

Let’s check out the Cost Inflation Index table. This cost inflation index chart will show how it has changed since 2001.

How to Apply Indexation to Long-Term Capital Assets?

Here's how you can apply indexation to the cost of asset acquisition:

(CII for the year of sale/transfer x the cost of asset acquisition) / CII for the year in which the asset was held by the assessee or the year 2001-2002 [whichever is later]

Here's the formula to calculate the indexed cost of asset improvement:

(CII for the year of sale/transfer x the cost of asset improvement) / CII for the year in which the asset improvement took place

Let's understand this with an example:

Prateek purchased a piece of land in the financial year 2002-2003 for ₹10,00,000. He sells the land in FY 2018-2019. What will be the indexed cost of acquisition?

CII for the year 2002-2003 was 105, whereas, for the FY 2018-2019, it was 280. Hence, the indexed cost of acquisition is:

10,00,000 x 280/105 = ₹26,66,667

Things to Note about Cost Inflation Index India

Here are a few important points that you need to consider while calculating the indexed cost of asset acquisition.

• If the asset is received at the assessee’s will, take the CII applicable for the year in which it was received. Ignore the actual purchase year during such instances.

• Improvement costs incurred before April 1, 2001, cannot be indexed.

• You cannot avail the benefits of indexation for debentures and bonds. However, RBI-issued sovereign gold bonds or capital indexation bonds can benefit from Cost Inflation Index.

What is the Meaning of Base Year in Cost Inflation Index?

The base year is basically the first year (2001-2002) of the Cost Inflation Index. It plays a pivotal role because the index values of all the other years are compared to the base year. It assists the government in understanding the increase in inflation percentage.

For any capital asset purchased before the base year of Cost Inflation Index, i.e. 2001-2002, assessees can consider the purchase price to be either the Fair Market Value (FMV) or actual cost as on the first day of the base year (whichever is higher). The benefit of indexation is then applied to the estimated purchase price. The FMV is calculated on the basis of the valuation report of a registered valuer.