Cost Inflation Index,Indexation and Long Term Capital Gains

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

FINANCIALYEAR COST INFLATION INDEX
2014-15 1024
2013-14 939
2012-13 852
2011-12 785
2010-2011 711
2009-2010 632
2008-2009 582
2007-2008 551
2006-2007 519
2005-2006 497
2004-2005 480
2003-2004 463
2002-2003 447
2001-2002 426
2000-2001 406
1999-2000 389
1998-1999 351
1997-1998 331
1996-1997 305
1995-1996 281
1994-1995 259
1993-1994 244
1992-1993 223
1991-1992 199
1990-1991 182
1989-1990 172
1988-1989 161
1987-1988 150
1986-1987 140
1985-1986 133
1984-1985 125
1983-1984 116
1982-1983 109
1981-1982 100

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.

Nature of Asset Short Term Capital Asset  Long Term Capital Asset
 (i) Shares in a company or any other security listed in a recognised stock exchange in India or a unit of a Unit Trust of India or a unit of a mutual fund specified under section 10(23D). Held for not more than 12 months.  Held for more than 12 months.
 (ii) Assets other than assets mentioned in (i) above.  Held for not more than 36 months. Held for more than 36 months.

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:

If a property is purchased in Financial year 1995-96 for Rs 20 lakh.It is sold  in Financial year(FY) 2011 -12 for Rs 80 lakh.Then Gain would be = Rs 80 lakh – 20 lakh = Rs 60 lakhBut if CII is considered then we need to calculate cost of 20 lakh of 1995-96 in the year 2011-2012From the table Inflation index in year 1995-96 is 281 and year 2011-2012 is 785 So Indexed cost of Rs 20 lakh in the year 2011-2012 is = 20 * (785/281) = 55.871So Long term capital gain = 80-55.871 = 24.128 lakh instead of Rs 60 lakh

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.

No of Shares Purchase Details Sale Details Indexed Purchase Price/share Indexed Capital Gain Non-Indexed Capital Gain
1000 Rs 10 in 15 Jan 2009 Rs 18 on 20 Feb 2012 10*785/497=15.795 (18-15.795)*1000=2205.23  (18-10)*1000=8000
 1000 Rs. 12  on 1 May 2010 Rs 18 on 20 Feb 2012  12*785/711=13.2489  (18-13.2489) *1000=4751.05 (18-12)*1000=6000
 500 Rs. 16 on 1 Feb 2011 Rs 18 on 20 Feb 2012  16*785/711=17.6653  (18-17.6653) *500=167.37  (18-16)*500=1000
Total 7123.65 15000

Tax liability based on indexation and non-indexation.

Indexed Non-Indexed
Total Capital Gain 7123.65  15000
 Tax % 20%  10%
 Tax to be paid 1424.73  1500

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.

No of Shares Purchase Details Sale Details Indexed Purchase Price/share Indexed Capital Gain Non-Indexed Capital Gain
1000 Rs 10 on 1 Jan 2008 Rs 17 on 30 Dec 2009 10* (632/551)=11.470 (17-11.470) *1000=5529.95  (17-10)*1000=7000
 1000 Rs. 15  on 1 May 2008 Rs 17 on 30 Dec 2009  15*632/582=16.2887  (17-16.2887) *1000=711.34 (17-15)*1000=2000
 500 Rs. 16 on 1 Dec 2008 Rs 17 on 30 Dec 2009  16*632/582=17.3745  (17-17.3745) *500=-187.285  (18-17)*500=500
Total 6054.01 9500

Tax liability based on indexation and non-indexation.

Indexed Non-Indexed
Total Capital Gain 6054.01  9500
 Tax % 20%  10%
 Tax to be paid 1210.08  950

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

 Purchase Details  Sale Details  Indexed Cost/Unit Long Term Capital Loss
20,000 units Rs 10/unit on Sep 2010 Rs 10.8177/unit on Oct 2011  10*785/711=11.0408  (10.8177-11.0408)*20000=-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.

FINANCIAL YEAR Real inflation %  75% of Real Inflation(.75 * Real Inflation) Increase=75% of Real Inflation * CII of previous year
Current CII = Previous Year CII + Increase (Earlier column)
1981-1982 100
1982-1983  12% 9% (.75% of 12) 9% of 100 = 9 109 (100+9)
1983-1984  8.563% 6.422% 6.422% of 109 = 7 116
1984-1985  10.344% 7.7586% 7.7586% of 116 = 9 125
1985-1986  8.5333% 6.4% 6.4% of 125 = 8 133
1986-1987  7.0173% 5.263% 5.263 % of 133 = 7 140
1987-1988  9.5237% 7.1428% 7.1428% of 140 = 10 150
1988-1989  9.7777% 7.333% 7.333% of 150 = 11 161
1989-1990  9.1097% 6.8323% 6.8323% of 161 = 11 172
1990-1991  7.7519% 5.8139% 5.8139% of 172 = 10 182
1991-1992  12.4542% 9.340% 9.340% of 182 = 17 199
1992-1993  16.080% 12.060% 12.060% of 199 = 24 223
1993-1994  12.556% 9.4170% 9.4170% of 223 = 21 244
1994-1995  8.1967% 6.1475% 6.1475% of 244 = 15 259
1995-1996  11.325% 8.494% 8.494% of 259 = 22 281
1996-1997  11.388% 8.5409% 8.5409% of 281 = 24 305
1997-1998  10.473% 7.8549% 7.8549% of 305 = 26 331
1998-1999  8.0564% 6.0423% 6.0423% of 331 = 20 351
1999-2000  14.435% 10.826% 10.826% of 351 = 38 389
2000-2001  5.827% 4.370% 4.370% of 389 = 17 406
2001-2002  6.568% 4.926% 4.926% of 406 = 20 426
2002-2003  6.573% 4.929% 4.929% of 426 = 21 447
2003-2004  4.773% 3.579% 3.579% of 447 = 16 463
2004-2005  4.896% 3.6717% 3.6717% of 463 = 17 480
2005-2006  4.7222% 3.5416% 3.5416% of 480 = 17 497
2006-2007  5.902% 4.4265% 4.4265% of 497 = 22 519
2007-2008  8.221% 6.1657% 6.1657% of 519 = 32 551
2008-2009  7.501% 5.6213% 5.6213% of 551 = 31 582
2009-2010  11.455% 8.591% 8.591% of 582 = 50 632
2010-2011  16.485% 12.36% 12.36% of 632 = 79 711
2011-12  13.8772% 10.44% 10.44% of 711 = 74 785

References:

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.

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