What Is Cost Inflation Index?

What is the Purpose of CII?

The cost inflation index table computes long term capital gains resulting from the sale or transfer of capital assets. Capital gains are the income from the sale or transfer of fixed assets like land, real estate, stocks, trademarks, and patents. Long-term assets are often recorded in accounting books. Despite rising asset prices, these investments cannot be revalued.

Due to their high selling price relative to their purchase price, the earnings or profits obtained from these assets remain high at the time of their sale. Assessors are therefore obligated to pay a higher rate of income tax on the profits from these assets.

By applying the cost inflation index to capital gains, the purchase price of an asset is subsequently adjusted to its selling price, resulting in decreased profits and taxes. The Direct Tax Central Committee published revised cost inflation index figures for applications from 2017 to 2018 in February 2018. This iteration uses 100 as the CII and moves the base year from 1981 to 2001. Accordingly, subsequent year indices have been modified. This adjustment of the base year was advocated to alleviate the problems faced by taxpayers in determining their tax obligations on the earnings from the sale of capital assets acquired prior to 1981.

What Is Cost Inflation Index?

The cost inflation index or CII is a metric used to quantify the annual increase in the price of products or assets caused by inflation. This chart of the cost inflation index is determined by the national govt. The indexation chart for calculating inflation is then published in the official gazette. The cost inflation index chart is specified by Section 48 of the Income Tax Act of India, 1961, and is published annually by the government.

The index is then utilized to compute long-term capital gains resulting from the transfer or sale of capital assets. The cost inflation index is computed relative to the base year, which is the first year in the index with a value of 100. The indexation of subsequent years is based on the base year in order to control the inflation rate increase. 

Old CII Table

New CII Table

How does CII Work?

We are aware that the prices of capital assets are likely to rise between the time of acquisition and the time of sale owing to inflation. Therefore, the sale of assets will likely improve the owner’s net worth, as the sale price will be more than the purchase price. As is common knowledge, the government imposes a tax on the sale or purchase of real estate; nevertheless, inflation forces the assessee to pay far more tax than is required.

Here, Cost Inflation Indexation enters the scene, since it adjusts the purchase price in accordance with the increasing sale price caused by inflation.

Before the end of each fiscal year, the Indian government determines the Cost Inflation Index.

Why and How is CII Calculated?

The price of the asset at the time of acquisition is indexed by the cost inflation index.

Cost Inflation Index = CII at the time of asset sale / CII at the time of asset acquisition.

Example:

In 2000, a guy purchased a property for Rs. 20 lakhs; in 2009, he sold it for Rs. 35 lakhs.   Approximately Rs. 15 lakhs have been earned during the years.

In the year 2000, the Cost inflation index was 389, whereas in 2009, it was 582.

The Cost Inflation Index is therefore = 582 / 389 = 1.49

Revision in CII

The Cost Inflation Index (CII) for the Fiscal Year 2022-23 (FY) has been released by the Central Board for Direct Taxes as a 331 with a notice dated 14 June 2022. This index will be used to measure inflation by the government.

What does a Base Year in CII Mean?

The base year is the initial year of the cost inflation index, and the value of the index is maintained at 100. Compare the index for all other years to the index for the base year to determine an inflation increase. For all investments purchased before to the base year of the Cost Inflation Index, taxpayers may accept the purchase price as higher than the actual cost or fair market value (FMV) on the first day of the base year, if the FMV is based on an assessment report from a registered appraiser.

The advantages of indexing apply to the computed purchase price. Initially, 1981-1982 served as the foundation year. However, it was difficult for taxpayers to assess residences purchased prior to April 1, 1981. Additionally, tax officials had difficulty relying on assessment reports. As a result, the government has decided to shift the base year to 2001 so that the assessment may be completed promptly and precisely. Taxpayers will gain from indexing capital assets acquired prior to April 1, 2001, assuming an actual price or FMV greater than the purchase price applicable on April 1, 2001.

What is Indexation?

Indexation is an effective method for reducing the taxation on investment returns. Indexation pertains to long-term investments, such as debt funds and other asset classes. Indexation assists in adjusting the investment buying price. You will be able to reduce your tax liability in this manner. Before considering indexation, it is necessary to comprehend inflation and capital gains.

Inflation is the gradual increase in the cost of goods and services. For instance, anything of Rs.100 now may be worth Rs.110 or more next year, and even more the year after that. Inflation affects your purchasing power in this manner.

It means that for the same amount of money, you will be able to purchase fewer goods in the future compared to the present. The price of a good or service will rise due to inflation.

How is Indexation applied for long-term capital assets?

Indexed Asset Acquisition Cost = (CII at the time of sale x Acquisition Cost) / (CII at the time of acquisition)

To compute the asset improvement cost index,

Indexed Asset Improvement Cost = (CII at the time of sale multiplied by the Cost of Asset Improvement) / CCI at the time of improvement.

Example:

A person acquired an asset for 1 lakh rupees during the fiscal year 1979–80. His property’s Fair Market Value (FMV) in the year 2000 was Rs. 2,20,000. He sold the property during 2015-2016.

Note: The asset was acquired prior to the base year (2001). Therefore, the CII for 2001, which is 100, will be considered.

In addition, the acquisition cost of an asset is always greater than its real cost or Fair Market Value.

hence, the acquisition cost is = Rs. 2,20,000

Indexed cost of acquisition = (254 x 2,20,000) / 100 = Rs. 5,58,000

Benefits of Indexation

Indexation is utilized to alter the purchase price of an investment to account for the impact of inflation. A greater purchase price reduces profits, which results in a lower effective tax rate.

Using indexation, you will be able to reduce your long-term capital gains, so reducing your taxable income. Indexation is the reason why debt funds are deemed superior to regular fixed deposits as a fixed-income investment alternative (FDs). Indexation makes the investment game a win-win situation.

The government’s Cost Inflation Index can be used to determine the indexation inflation rate (CII). The Central Government decides the index values, which are updated on the website of the income tax department.

How can Indexation Reduce Tax Liabilities on LTCG for Assesses?

The CBDT has adjusted the Cost Inflation Index for the 2021-22 fiscal year from 201 to 317. The Cost Inflation Index for the 2020-21 fiscal year was 201. Since CII is used to determine the inflation-adjusted asset acquisition cost for the calculation of LTCG assets, this indexation can reduce tax obligations.

Assesses can reduce the amount of tax due on long-term capital gains realized through the sale of assets such as Debt mutual funds and real estate. It is possible by adjusting their total invested amount in accordance with the asset purchase CII. For instance, any gain realized by an individual via the transfer or sale of an asset is subject to applicable capital gains taxes, regardless of its duration. If the assets are held for less than 24 months, the gains on their transfer are considered short-term capital gains and are not indexed.

If the assessed person holds the asset for more than 24 months at the time of sale or transfer, however, the CII application will be subject to a 20% tax rate. When CII is applied to the wealth gain, the gain amount is automatically lowered. Consequently, the taxed amount is also lowered, reducing the assessor’s LTCG tax burden.

This reduction in tax obligations is one of the primary causes for the rise in pension fund subscriptions and fixed-term pension issuance (FMP). Implementing CII in LTCG thereby permits beneficiaries to retain a surplus after paying taxes on long-term gains, which can be invested in other financial instruments.

How does Indexation Work for Debt Funds?

Let’s assume that in July 2016 you invested in a debt fund. Your total investment was Rs. 10,000, and you purchased the units at a NAV of Rs. 10.  In August of 2019, three years later, you redeem your investments for a NAV of Rs.20. Therefore, the value of your investments when you sold them was Rs. 20,000. Your investment generated capital profits of 10,000 rupees.

However, you are not required to pay tax on the entire Rs. 10,000. Given that your holding period was three years, indexation will diminish the value of your long-term capital gains. To calculate the Indexed Cost of Acquisition (ICoA), the following formula must be applied:

ICoA = (CII of the year of sale/CII of the year of purchase) * Original cost of acquisition

In the preceding example, the indexed cost of acquisition is Rs.10,947, or (10,000 * 289/264).

Therefore, rather than Rs.10,000, your capital gains will be Rs.9,053, or Rs (Rs.20,000 – Rs.10,947).

Using indexation, you may have avoided paying tax on Rs.947 of gains. Your tax will be calculated based solely on Rs. 9,053, amounting to Rs. 1,810. The benefit of indexation is most effective with a longer holding period. With a 5-year holding period, the long-term capital gains tax on debt funds can be reduced from 20% to 6% to 7%. This is how indexation allows you to reduce your tax liability on long-term capital gains from debt mutual funds and increase your profits.

Things to note about CII India

When estimating the indexed cost of acquiring an assessor’s assets, assessors must consider several crucial factors.

• If the asset is acquired at the request of the assessor, CII will be evaluated in the year it was acquired. In this situation, the actual year of acquisition of the asset is irrelevant.

• Prior to April 1, 2001, improvement costs are not subject to indexing.

• The benefits of the index do not apply to bonds, with the exception of government gold bonds and RBI-issued capital index bonds.

FAQ

• What is the relevance of changing the base year?

Initially, the base year was deemed to be 1981-1982. The valuation of assets acquired prior to April 1, 1981, however, presented difficulties for taxpayers. Additionally, tax officials had difficulty relying on the valuation reports. As a result, the government decided to move the base year to 2001 so that valuations can be performed efficiently and precisely.

So, for a capital asset acquired prior to April 1, 2001, taxpayers may use the greater of the actual cost or FMV (Fair Market Value) as of April 1, 2001 as the purchase price and claim indexation.

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