InvestorQ : Can you explain how to rework my capital gains using cost inflation index?
Priyanka N made post

Can you explain how to rework my capital gains using cost inflation index?

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NISHA Nayak answered.
2 years ago
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The Cost inflation index or the CII is about standardizing the inflation impact measurement for all classes of investors and tax assessees. Cost Inflation Indexation is a technique to reduce tax payments by employing a price index which adjusts for inflation. In other words, indexation is the process that takes into account inflation from the time you bought the asset to the time you sell it. The purchase date and the sale date are considered as the two data points for the purpose of indexation. The way it works is that it allows you to inflate the purchase price of the asset to take into account the impact of inflation. Not only the purchase cost but even the cost of improvements in case of property are allowed to be inflated to the current values and that substantially reduces your tax liability. The end result is that you get the benefit of lowering your tax liability. Inflation erodes the value of the asset over time as we explained earlier and so the tax department gives you a benefit of reducing your capital gains for tax purposes by inflating your cost of acquisition in line with inflation.

There is a practical problem here. If the Income Tax department were to allow individuals to apply the rate of inflation then different individuals would apply different rates of inflation. For example, somebody may apply June inflation and somebody may apply May inflation. Somebody may apply rural inflation while others may apply urban inflation. Similarly, some may apply CPI inflation while others may apply WPI inflation. The need of the hours is to standardize the entire process and that is what the Income Tax Department does through the announcement of annual Index numbers for the purpose of tax calculation. Check the table on index numbers below:

Index Values announced by Income Tax Department (Base is 2001-12)

FY 2001-02

FY 2002-03

FY 2003-04

FY 2004-05

FY 2005-06

FY 2006-07

100

105

109

113

117

122

FY 2007-08

FY 2008-09

FY 2009-10

FY 2010-11

FY 2011-12

FY 2012-13

129

137

148

167

184

200

FY 2013-14

FY 2014-15

FY 2015-16

FY 2016-17

FY 2017-18

FY 2018-19

220

240

254

264

272

280

These index numbers above are the guide that all individuals paying capital gains must use for indexing. When you buy in a particular and sell in another year, you must multiply the original cost of acquisition by the selling year index number and divide by the buying year index number. The result will be the indexed cost of acquisition which will be higher than the original cost of acquisition. You only need to pay capital gains tax on the indexed value of capital gains which is (the difference between the selling value and the indexed cost of acquisition.
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