InvestorQ : Can you explain how indexation reduces my capital gains on debt funds with an example?
Aditi Sharma made post

Can you explain how indexation reduces my capital gains on debt funds with an example?

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Aashna Tripathi answered.
2 years ago
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To understand the point on indexation let us assume that you purchased a debt fund (growth plan) in September 2010 worth Rs.64 lakhs and sold the debt funds at Rs.127 lakhs in Sept 2017. Let s also look at how the indexation will be applied before the capital gains are actually calculated. Here is how your capital gains will be calculated for tax purposes after imputing the benefit of indexation…

Particulars

Amount

Indexation

Amount

Cost of Purchase

Rs.64 lakhs

Actual Capital Gain

Rs.63 lakhs

Month of Purchase

Sept 2010

Indexed Cost of Buy

{63x(272 / 167)

Fiscal Year

FY 2010-11

Rs.103 lakhs

Sale Value

Rs.127 lakhs

Sale Value

Rs.127 lakhs

Month of Sale

Sept 2017

Indexed Capital Gain

Rs.24 lakhs

Fiscal Year

FY 2017-18

Tax at 20%

Rs.4.80 lakhs

What really strikes you in the above illustration is how the indexation has caused a sharp fall in your tax outgo. In the above Illustration, the taxable capital gains come down from Rs.63 lakh to Rs.24 lakh. The tax paid is just Rs.4.80 lakhs. The effective tax paid on LTCG on the sale of debt funds, therefore, works out to just 7.6% (4.80 lakhs / 63 lakhs). This is the benefit that indexation proffers to the investor when calculating the tax on capital gains.
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