The world’s economy is dynamic and subject to constant change. This change is evident from a decrease in the purchasing power of money due to a sustained rise in the prices of goods and services.
The phenomenon of a reduction in the value of money, which leads to an increase of an individual’s cost of living, is known as inflation.
Cost Inflation Index or CII is a tool used in the calculation of an estimated yearly increase in an asset’s price as a result of inflation.
The Central Government fixes this index and publishes it in its official gazette for measuring inflation. This index, notified each year by the Government is defined under Section 48 of the Income Tax Act, 1961.
What is Cost Inflation Index?
The cost inflation index (CII) is a means to measure inflation, which is used in the computation of long-term capital gains concerning the sale of assets. Cost inflation takes into account the Consumer Price Index (CPI) for a given year for urban non-manual employees for the preceding year.
What is the Purpose of CII?
A Cost Inflation Index table is used to calculate the long term capital gains from a transfer or sale of capital assets. Capital gain refers to the profit acquired from the sale/transfer of any capital assets, including land, property, stocks, shares, trademarks, patents, etc.
In accounting, usually, long term capital assets are recorded at their cost price in books. Thus, despite rising prices of assets, these capital assets cannot be revalued.
Thus, at the time of sale of these assets, the profit or gain acquired from them remains high due to their high sale price in comparison to their purchase price. As a result, assessees also have to pay a higher income tax on the gains from these assets.
With the application of Cost Inflation Index for capital gain, in the long run, the purchase price of assets is adjusted according to their sale price, leading to lower profits and lower tax amount on them.
The Central Board of Direct Taxes in February 2018 notified new Cost Inflation Index numbers applicable from 2017-18 onwards. In this revision, there was a shift from the old base year of 1981 to 2001, with 100 taken as its CII. The indices for subsequent years were also revised accordingly.
This revision in the base year was prompted to solve the difficulties faced by taxpayers in the calculation of tax payable for gains from capital assets purchased on or before 1981.
Following are two tables illustrating new and old Cost Inflation Index for the last ten financial years –
Old CII Table
Financial Year | CII |
2007-08 | 551 |
2008-09 | 582 |
2009-10 | 632 |
2010-11 | 711 |
2011-12 | 785 |
2012-13 | 852 |
2013-14 | 939 |
2014-15 | 1024 |
2015-16 | 1081 |
2016-17 | 1125 |
New CII Table
Financial year | Cost Inflation Index |
2024-25 | 363 |
2023-24 | 348 |
2022-23 | 331 |
2021-22 | 317 |
2020-21 | 301 |
2019-20 | 289 |
2018-19 | 280 |
2017-18 | 272 |
2016-17 | 264 |
2015-16 | 254 |
2014-15 | 240 |
2013-14 | 220 |
2012-13 | 200 |
2011-12 | 184 |
2010-11 | 167 |
2009-10 | 148 |
2008-09 | 137 |
2007-08 | 129 |
2006-07 | 122 |
2005-06 | 117 |
2004-05 | 113 |
2003-04 | 109 |
2002-03 | 105 |
2001-02 | 100 |
How is Cost Inflation Index used in Income Tax?
Long-Term Capital Assets are recorded at cost price in books. Despite increasing inflation, they exist at the cost price and cannot be revalued. When these assets are sold, the profit amount remains high due to the higher sale price as compared to the purchase price. This also leads to a higher income tax.
The cost inflation index is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes to benefit taxpayers. To benefit the taxpayers, the cost inflation index benefit is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes.
What is the Concept of the Base Year in Cost Inflation Index?
The base year is the first year of the cost inflation index and has an index value of 100. The index of all other years is compared to the base year to see the increase in inflation percentage. For any capital asset purchased before the base year of the cost inflation index, taxpayers can take the purchase price higher of the “actual cost or Fair Market Value (FMV) as on the 1st day of the base year. Indexation benefit is applied to the purchase price so calculated. FMV is based on the valuation report of a registered valuer.
Why is Cost Inflation Index Calculated?
The Cost Inflation Index is calculated to match the prices to the inflation rate. In simple words, an increase in the inflation rate over time will lead to a rise in prices.
How is Indexation Applied for Long-Term Capital Assets?
Indexation is applied to the cost of asset acquisition to adjust the price of assets in accordance with inflation.
Following is the formula to calculate indexed cost of asset acquisition –
Indexed Cost of Asset Acquisition = (CII for year of sale or transfer x Cost of asset acquisition)/ CII for first year in the holding period of asset or year 2001-02, whichever comes later |
Following is the formula to calculate the indexed cost of asset improvement–
Indexed Cost of Asset Improvement = (CII for year of sale or transfer x Cost of asset improvement)/ CII for year during which the asset improvement took place |
Example of Application of Indexation for Long-Term Capital Assets
Mr Paul invested in the purchase of a capital asset in Financial Year 1994-95 for Rs. 1,00,000. The Fair Market Value of this capital asset on April 1st 2000 was Rs. 2,20,000. He then proceeded to sell this asset in the financial year 2015-16.
Following is a calculation of the indexed cost of asset acquisition –
In the case mentioned above, the asset is purchased before the base year. Therefore, cost of asset acquisition, in this case, = Higher between FMV and actual cost of the asset, as on April 1st 2000.
Therefore, the cost of acquisition of this asset = Rs. 2,20,000.
CII for the year 2001-02 and 2015-16 is 100 and 254 respectively.
Therefore, indexed cost of asset acquisition = (2,20,000 x 254)/100 = Rs. 5,58,800
Things to Note about Cost Inflation Index India
While calculating the indexed cost of asset acquisition of an assessee, there are a few critical points assessees should bear in mind.
These are –
- If an asset is received at an assessee’s will, CII is considered for the year in which it is received. In this case, the asset’s actual purchase year is to be ignored.
- Any improvement cost incurred before April 1st 2001 is not viable for indexation.
- Benefits of indexation are not applicable for debentures or bonds, apart from RBI issued sovereign gold bonds or capital indexation bonds.
How Can Indexation Reduce Tax Liabilities on LTCG for Assesses?
Assessees can bring down their quantum of tax applicable on long term capital gains acquired from the transfer of assets like debt mutual funds, real estate, etc. by adjusting their total invested amount in accordance with the CII of asset purchase and sale years.
For example, any gain acquired by an assessee from transfer or sale of a property will attract relevant capital gains taxes, whether long or short term. If the holding period of said property is less than 24 months, then the gains arising from a transfer of these assets are considered short term capital gain and are not applicable for indexation.
However, if assessees have held an asset for more than 24 months during the time of sale or transfer, then they are taxed at a rate of 20% with CII application.
When CII is applied to gains from property, the quantum of profit is automatically reduced. Thus, the amount on which taxes will be levied will also be reduced, thus bringing down an assessee’s tax liabilities on LTCG.
This reduction in tax liability is one of the primary reasons for an increase in the subscriptions and issuance of bond funds and Fixed Maturity Plans (FMP). The implementation of CII on LTCG, thus, can leave assessees with a surplus after their tax payments on long-term gains, which they can further utilise to invest in other financial instruments.
FAQs
What is the base year of cost inflation index?
The first year for which the cost inflation index is calculated is 1981. The year 1981 has a value of 100 on the index.
How to calculate cost inflation index?
The indexation cost is calculated as (Index for the year of sale/Index for the year of acquisition) x cost.