Cost Inflation Index

Introduction

Imagine this scenario: you bought a property or an asset a few years ago, and are now looking to sell it at a profit. However, you realise that the amount of tax you need to pay on the gains has skyrocketed due to the inflationary impact on the asset's value. This defines the Cost Inflation Index (CII). 

Taxpayers and investors use CII to account for inflation and reduce their tax burden. This article explores the Cost Inflation Index meaning, how it works, and how it can benefit you in managing your taxes and investments.

What is Cost Inflation Index?

The Cost Inflation Index estimates the increase in the price of general goods and services in India over a specific period. The government has notified the Cost Inflation Index meaning under Section 48 of the Income Tax Act, 1961. 

The CII table provides information about the price increase through long-term capital gains over a specific period. Long-term capital gains are profits from the sale of capital assets such as stocks, bonds, property, land etc. 

The Cost Inflation Index accounts for the increase in the net worth of an individual from  long-term capital gains and matches it with the current inflation to showcase their purchasing power. The index also considers the tax owed to the government on the profits made from the sale of capital assets. 

Cost Inflation Index Table from FY 2001-02 to FY 2023-24

Listed below is the Cost Inflation Index for FY 2023-24 with previous years’ results. 

What Is the Purpose of CII?

A company records the long-term capital assets, such as machinery, in the balance sheet at their cost price. However, with time and rising inflation, the current price of these capital assets may increase, making it impossible to revalue them in the accounting books. 

When a business or an individual sells capital assets, the long-term capital gains remain high as the sale price is higher than the original cost price. As a result, the assessee is liable to pay a higher long-term capital gains tax for the profit amount. 

The Cost Inflation Index definition also applies to capital gains. It adjusts the purchase price of the capital assets according to the sale price. The process allows assessees to show lesser long-term capital gains to ensure they do not pay higher taxes.

How Is the Cost Inflation Index Used In Income Tax?

The Cost Inflation Index measures inflation estimated by the Indian government every year. It adjusts the purchase price of an asset for inflation by multiplying it by the ratio of CII of the year of sale and CII of the year of purchase. 

The Cost Inflation Index (CII) is used in income tax to adjust the purchase price of an asset for inflation when calculating capital gains tax. It affects the tax liability of the assessees by lowering their long-term capital gains. With a lower capital gains amount, the assessees have to pay a lower LTCG  tax. 
 

What is the concept of the base year in the Cost Inflation Index?

The base year (2001-02) is the first year for calculating the CII with an index of 100. To estimate inflation, the index for all subsequent years is compared to the base year. It calculates the results in percentage value. However, a taxpayer may have purchased a capital asset before the base year. In such a case, the taxpayer must analyse the actual cost price or the Fair Market Value (FMV) and choose the lesser one. 

Why is Cost Inflation Index calculated?

Inflation erodes the purchasing power of money, which means that the same amount of money buys less over time. When taxpayers sell assets such as property, gold, or other capital assets, the acquisition or cost price must be adjusted to arrive at the actual gain or loss on the sale.

Who Notifies the Cost Inflation Index?

The Indian government is responsible for notifying the Cost Inflation Index by listing it in the official gazette. The Central Board of Direct Taxes (CBDT), a part of the Ministry of Finance, helps the government to notify the CII. The notification includes the CII for each financial year, starting from the base year of 2001-02. Taxpayers can access the CII notifications on the official website of the Income Tax Department of India.

Why is the base year of the Cost Inflation Index changed to 2001 from 1981?

Initially, the central government set 1981-82 as the base year for calculating the Cost Inflation Index. However, taxpayers found it difficult to value their long-term capital assets purchased before 1st April 1981. With limited technological advancement in 1981, the government was also finding it difficult to rely on valuation reports for capital assets. Hence, they changed the base year to 2001-02. 

If taxpayers have purchased the asset before 1st April 2001, they can choose the lower valuation out of the actual cost price or the Fair Market Value as of 1st April 2001. 
 

How is indexation benefit applied to long-term capital assets?

The motive behind using CII is to adjust the purchase price of the capital assets against the sale value. When the CII’s indexation calculations are applied to the purchasing price or acquisition cost, the resulting amount becomes the ‘Indexed Cost Of Acquisition.’ 

Here are the formulas for the Indexed Cost of Acquisition and the Indexed Cost of Improvement.

Indexed Cost of Acquisition: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the first year of the asset purchase or year 2001-02, whichever is later X cost of acquisition 

Indexed Cost of Improvement: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the year of asset improvement X cost of improvement 
 

Things to Note about Cost Inflation Index India

The nature of the asset's sale, transfer, or improvement can differ for assessees. Here are the things to note about Cost Inflation Index India.

●    If an assessee has received the asset or property in the will, then CII is calculated by taking the index for the year of receipt. The actual year of property purchase is not considered in this case. 

●    The improvement cost incurred before 1st April 2001 is not considered. 

●    Index benefit is not allowed in the case of debentures or bonds, except for sovereign gold bonds and capital indexation bonds.

●    Starting 1st April 2023, assessees can not claim indexation benefits for debt funds. 

How Can Indexation Reduce Tax Liabilities on LTCG for Assesses?

Every assessee has to pay a long-term capital gains tax on the profits made by the sale of assets. These are assets that the assessee has held for over 24 months. Assessees can utilise the Cost Inflation Index to adjust their profits against the asset's purchase price and lower their profits along with the quantum of the tax applicable. This can also help reduce the tax liability for real estate investors, equities, etc., by adjusting their originally invested amount. 

To calculate the tax liability on LTCG, the asset's purchase price is adjusted for inflation using CII. The indexed acquisition cost is then deducted from the sale price to arrive at the capital gains. By adjusting the purchase price for inflation, indexation increases the asset's purchase price, which reduces the taxable capital gains. If the assessee has held the asset for over 24 months, LTCG tax is applicable at 20%. 

The assessees use CII for its primary reason to lower the tax liability as the capital gains are significant in terms of amount. 

Practical Examples 

Here are some practical examples better understand the meaning of the Cost Inflation Index. You can use a Cost Inflation calculator to make the calculations. 

Case 1 
Deepika purchased a flat in the year 2003-04 for Rs 50,00,000. After holding it for several years, she sold the flat in 2015-16. 

Indexed Cost of Acquisition: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the first year of the asset purchase or year 2001-02, whichever is later X cost of acquisition 

In this case, CII for the year 2003-04 is 109 and for 2015-16 is 254. 
Hence, the indexed cost of acquisition will be Rs 50,00,000 x 254/109 =  Rs 1,16,513,76

Case 2 
Riddhika purchased a capital asset in FY1998-99 for Rs 5,00,000. The Fair Market Value (FMV) of the asset as of 1st April 2001 was Rs 7,00,000. She sells the asset in FY 2018-19. 

Indexed Cost of Acquisition: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the first year of the asset purchase or year 2001-02, whichever is later X cost of acquisition 

In this case, Riddhika bought the asset before the base year. Hence, the cost of acquisition = Higher actual cost or FMV on 1st April 2001, i.e. Rs 7,00,000. 

CII for the year 2001-02 is 100, and for 2018-19 is 280. 
Hence, the indexed cost of acquisition will be Rs 7,00,000 x 280/100 =  Rs 19,60,000

Case 3 
Moksha invested Rs 2,50,000 in equity shares on 1st August 2018 and sold the shares on 1st April 2021.

Indexed Cost of Acquisition: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the first year of the asset purchase or year 2001-02, whichever is later X cost of acquisition 

In this case, CII for the year 2017-18 is 272 and for 2021-22 is 317. 
Hence, the indexed cost of acquisition will be Rs 2,50,000 x 317/272 =  Rs 2,91,360

Case 4 
Prayag bought Sovereign Gold Bonds for Rs 3,75,000 in July 2011. He prematurely withdrew the bonds at the prevailing market price of Rs 4,00,000 in March 2019. 

Indexed Cost of Acquisition: Cost Inflation Index (CII) for the year of asset transfer (sale) / CII for the first year of the asset purchase or year 2001-02, whichever is later X cost of acquisition 

In this case, CII for the year 2011-12 is 184 and for 2018-19 is 280. 
Hence, the indexed cost of acquisition will be Rs 3,75,000 x 280/184 =  Rs 5,70,652