Cost Inflation Index(CII) is a measure of inflation that is used for computing long-term capital gains on sale of capital assets. It comes under Section 48 of the Income-Tax Act.

Cost Inflation Index from Financial Year 1981-82 to Financial Year 2011-12

Inflation Index is reported in terms of Financial Year, not Assessment Year. In India the year for financial transactions start from 1 st April and ends on 31st March following year. For example For any transaction between 1st April 2010 to 31st Mar 2011 the Indexation for year 2010-2011 i.e 711 would be used.

What are capital assets?

Capital Assets are the assets  which can be held by a person for examples Mutual Funds(Equity, Debt), Real Estate , Shares ,Gold, Fixed Maturity Plan(FMP) , Fixed returns Instruments such as Fixed Deposit.

What are Long Term and Short Term capital assets?

Assets are classified as Long Term or Short Term with reference to the period of holding of the assets till it is transferred. The classification is made on the following basis.

How does CII help in capital gain/loss computation? 

Cost of acquisition is historical, the concept of indexed cost allows the taxpayer to factor in the impact of inflation on cost. Consequently, a lower amount of capital gains gets to be taxed than if historical cost had been considered in the computations. For example:

In indexation and capital gain parlance, the purchase price is called indexed cost of acquisition

Indexation helps to counter the erosion in the value of the asset over a period of time. Using the inflation index, one needs to increase the purchase price of the asset so that it reflects inflation-adjusted true price in the year in which it is sold.

Can Indexation be used for all asset classes?

No. There are some asset classes where you have the choice of using Indexation or not Such as: Mutual Funds(Equity, Debt), Real Estate , Shares ,Gold, Fixed Maturity Plan(FMP). But Fixed returns Instruments such as Fixed Deposit, Recurring Deposit, POMIS, NSC, Interest on Saving Bank Account are NOT part of it.

Tax liability on capital gain with indexation and without indexation

For Long term Capital Gains for  debt mutual fund units the current tax rate are

• Either 10% without Indexation OR
• 20% with Indexation

For long-term gains on property, gold etc the tax rate is 20% with indexation of cost.

Long term capital gains from equities are not taxed if shares are sold through recognized stock exchange and Securities Transaction Tax, or STT, is paid on the sale.

Is it necessary to use Indexation?

No. You can choose with indexation or without indexation for every asset sale for the total capital gain that you have only in case of listed shares and mutual fund units. In some cases it may be better to pay just 10%. For instance if you bought a stock 10 years ago, chances are it has multiplied so much that any amount of indexation doesn’t cut much into your profits; you are then better off paying 10% of the unindexed gain rather than 20% of indexed gains. Explained with example later.

Calculation of Tax liability for Different Purchase Dates as in case of Stocks

If you have bought :

• 1000 units at Rs. 10 on 15 Jan 2006,
• 1000 more units at Rs. 12  on 1 May 2010
• 1000 more units at Rs. 16  on 1 Feb 2011

and sold

• 2500 units at Rs. 18  on 20 Feb 2012,

Each purchase/sale transaction is matched on a First-In-First-Out basis(FIFO). So Three cases arise.

Tax liability based on indexation and non-indexation.

You can choose which one of the two you want, and in this case the indexed option is better – you pay lower taxes.

Non-indexation tax liability better than Indexed tax liability

Using the example given in CapitalMind:How To Calculate Long Term Capital Gains Tax If you have bought :

• 1000 units at Rs. 10 on 1 Jan 2008,
• 1000 more units at Rs. 15 on 1 May 2008
• 1000 more units at Rs. 16 on 1 Dec 2008

and sold

• 2500 units at 17 on 30 December 2009,

Each purchase/sale transaction is matched on a First-In-First-Out basis(FIFO). So Three cases arise.

Tax liability based on indexation and non-indexation.

In this case the non-indexed option is better – you pay lower taxes.

Can there be long term capital loss after indexation?

Yes there can be long term capital loss. For example if you bought FMP at Rs 10 per unit for 2,00,000 in Sep 2010 and it got matured on Oct 2011 at cost of Rs 10.8177. As shown in table below there is a long term capital loss of Rs 4461.75

If the capital loss cannot be set off against the capital gain of that particular year then you can you need to report in your income tax return and can carry forward for the next eight years.

When is CII notified?

It is notified by the Central Government every year taking 1981-82 as base year.. For example: Cost Inflation Index for Financial year 2011-12 was notified by CBDT vide circular 35/2011 dated 23.06.2010

How is CII calculated?

Section 48 of the Income-Tax Act defines the index as what is notified by the Central Government every year, having regard to 75 per cent of average rise in the consumer price index (CPI) for urban non-manual employees for the immediately preceding previous year.

References:

• Taxguru:Cost Inflation Index meaning and Index for all the years
• Jagoinvestor:How to Calculate Capital Gains and What is Indexation ?
• CapitalMind:How To Calculate Long Term Capital Gains Tax

Note: While efforts have been made to provide correct information, this is our understanding of the CII and  tax law. Apologies upfront for any mistakes. Please let us know and we will correct.

Did it help you in understanding CII, calculation of long term capital gains? Have be missed something or skipped or there are some mistakes please let us know.