What is the cost inflation index all about? How is it calculated? The cost Inflation Index determines the long-term capital gains from the sale of capital assets. Learn more about this important tool here!
The Cost Inflation Index (CII) is a measure used to calculate the projected yearly rise in the price of an asset due to inflation. This index is set by the Central Government and published in the official gazette to measure inflation. Section 48 of the Income Tax Act of 1961 defines this index, which is notified by the government each year.
Due to an increase in the price of goods and services, the purchasing power of money has deliberately fallen. Purchasing power refers to the number of goods bought with one unit of money. For example, if 5 units of goods can be purchased today for ₹200, it might be possible that tomorrow 5 units of goods may not be available for that price.
Say 5 units are available for ₹300. A cost inflation index is an effective tool to estimate the increase in the prices of goods, services, and assets from year to year due to inflation.
The cost Inflation Index is used to determine the long-term capital gains from the sale of capital assets. The profit acquired from the sale or transfer of any capital asset, including the property of land, building, stock, shares, patents, trademarks, etc. At the time of the sale of these assets, due to the high sale price, the gains or profits acquired remain high. In the long run, with the application of the Cost Inflation Index, the purchase of assets can be adjusted according to their sale price.
What is Cost Inflation Index?
Cost Inflation Index (CII) is a measure of inflation that is used to calculate the gains on long-term assets such as property, gold, and debt mutual funds. It is an index number that represents the increase in prices of goods and services due to inflation over a period of time. The CII is released by the Central Board of Direct Taxes (CBDT) every financial year.
New Cost Inflation Index Table for the Financial Years
The new CII table for the financial years 2021-22 and 2022-23 are as follows:
Financial Year Cost Inflation Index 2021-22 317 2022-23 (proposed) 344
Cost Inflation Index Table from FY 2001-02 to FY 2024-25
| Financial Year | Cost Inflation Index (CII) |
| 2001-02 | 100 |
| 2002-03 | 105 |
| 2003-04 | 109 |
| 2004-05 | 113 |
| 2005-06 | 117 |
| 2006-07 | 122 |
| 2007-08 | 129 |
| 2008-09 | 137 |
| 2009-10 | 148 |
| 2010-11 | 167 |
| 2011-12 | 184 |
| 2012-13 | 200 |
| 2013-14 | 220 |
| 2014-15 | 240 |
| 2015-16 | 254 |
| 2016-17 | 264 |
| 2017-18 | 272 |
| 2018-19 | 280 |
| 2019-20 | 289 |
| 2020-21 | 301 |
| 2021-22 | 317 |
| 2022-23 | 331 |
| 2023-24 | 348 |
How is the Cost Inflation Index used in Income Tax?
The CII is used in income tax to adjust the purchase price of an asset for inflation over time. This adjustment is called “indexation”. When an asset is sold, the capital gains tax is calculated based on the indexed purchase price of the asset. This reduces the amount of tax payable on the sale of long-term assets.
How is the Cost Inflation Index used in Income Tax?
Long-Term Capital Assets are recorded at their original cost price in the books and cannot be revalued despite increasing inflation. When these assets are sold, the profit amount tends to be higher due to the increased sale price compared to the purchase price, resulting in higher income tax liability.
To provide relief to taxpayers, the cost inflation index is applied to long-term capital assets. This indexing adjusts the purchase cost based on inflation, which reduces the profits and consequently lowers the tax liability. This benefit of the cost inflation index helps taxpayers by increasing the purchase cost, resulting in reduced profits and lower taxes.
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Who Notifies the Cost Inflation Index?
The cost inflation index is determined by the Central Government through notification in the official gazette. It is calculated as 75% of the average rise in the Consumer Price Index (urban) for the immediately preceding year. The Consumer Price Index compares the current price of a basket of goods and services with the cost of the same basket in the previous year to calculate the increase in prices, representing the overall economy.
How is Indexation benefit applied to long-term capital assets?
The process of applying indexation benefit involves the following steps:
- Determine the cost of acquisition: This is the actual price paid to acquire the asset, including any incidental expenses such as brokerage charges, legal fees, etc.
- Determine the cost inflation index (CII) for the year of acquisition and the year of sale: The CII is published by the government and represents the inflation index for a particular financial year.
- Calculate the indexed cost of acquisition: Multiply the cost of acquisition by the CII of the year of sale and divide it by the CII of the year of acquisition. The result is the indexed cost of acquisition.
- Calculate the indexed long-term capital gains: Subtract the indexed cost of acquisition from the selling price of the asset. The resulting amount is the indexed long-term capital gains.
- Apply the applicable tax rate: The indexed long-term capital gains are subject to tax at the applicable rate for long-term capital gains, which is typically lower than the tax rate for short-term capital gains.
Indexed Cost of Acquisition = (Cost of Acquisition) × (CII of the Year of Sale) / (CII of the Year of Acquisition)
Where:
- Cost of Acquisition is the actual price paid to acquire the asset, including incidental expenses.
- CII of the Year of Sale is the cost inflation index for the year in which the asset is sold.
- CII of the Year of Acquisition is the cost inflation index for the year in which the asset was acquired.
The formula for calculating the cost of improvement for a long-term capital asset is as follows:
Cost of Improvement = (Actual Cost of Improvement) × (CII of the Year of Improvement) / (CII of the Year of Acquisition or Improvement)
Where:
- Actual Cost of Improvement refers to the expenses incurred for improving or enhancing the asset.
- CII of the Year of Improvement is the cost inflation index for the year in which the improvement was made.
- CII of the Year of Acquisition or Improvement is the cost inflation index for the year in which the asset was acquired or the improvement was made.
The cost of improvement is used to increase the indexed cost of acquisition, resulting in a higher cost base and lower taxable capital gains when the asset is sold. This calculation accounts for inflation and the expenses related to improving the asset over time.
How is CII Useful in Reducing Tax?
Indexation can provide significant tax savings on long-term capital gains when selling an asset. However, it’s important to note that indexation is not applicable to short-term capital gains or losses. Additionally, Non-Resident Indians are not eligible for this benefit.
To qualify for indexation on long-term capital gains, the following criteria must be met:
- Multiply the cost of acquisition of the asset by the cost inflation index of the year it was transferred.
- Divide the above figure by the cost inflation index for the year in which the asset was acquired. If the asset was purchased before 1981, consider using the cost inflation index of the year 1981.
- If any improvements were made to the asset, adjust the cost inflation index by multiplying it with the CII of the year the improvement was made.
Why is Cost Inflation Index calculated?
The CII is calculated to adjust the cost of acquisition of assets to inflation. It helps in reducing the tax burden on taxpayers who hold long-term assets. The indexation benefit is provided to account for inflation and prevent taxpayers from paying taxes on inflationary gains.
Why is the base year of the Cost Inflation Index changed to 2001 from 1981?
The base year of the CII was changed from 1981 to 2001 to reflect the changes in the economy and prices over time. The change was made to make the CII more relevant and accurate in calculating the gains on long-term assets.
How is indexation benefit applied to long-term capital assets?
The indexation benefit is applied by adjusting the purchase price of the asset for inflation using the CII. The formula for calculating the indexed cost of acquisition is as follows:
Indexed cost of acquisition = Actual cost of acquisition x (CII for the year of sale/CII for the year of purchase)
The indexed acquisition cost is then used to calculate the capital gains tax on the asset’s sale.
How to Calculate the Cost Inflation Index?
The CII is calculated based on the All India Consumer Price Index (CPI). The formula for calculating the CII is as follows:
CII = CPI (current year) / CPI (base year) x 100
How is CII Useful in Reducing Tax?
The CII is useful in reducing tax as it provides indexation benefits to taxpayers who hold long-term assets. Indexation adjusts the purchase price of the asset for inflation over time, which reduces the taxable gain on the sale of the asset. This helps in reducing the tax burden on taxpayers.
What Should Be Kept in Mind When It Comes to the Cost Inflation Index?
- CII will be used to determine inflation-adjusted cost only for assets that can be updated for inflation (indexation benefit). As a result, the CII value cannot be used to calculate long-term capital gains (LTCG) or long-term capital losses (LTCL) on equity mutual funds because amounts over Rs.1 lakh each fiscal year are taxed at a flat rate of 10% with no indexation benefit.
- Before the levy of LTCG tax, a CII number will be necessary to calculate LTCG for FY 2022-23 for assets where indexation is permitted. These gains will be taxed when the income tax returns (ITR) for the fiscal year 2022-23 are filed.
What Does the Base Year of CII Mean?
The cost inflation index is calculated to align prices with the inflation rate. Expressed, rising prices result from an increase in the inflation rate over time. The cost inflation index’s base year is the first year and has an index value of 100.
The index of all subsequent years is compared to the base year to determine the percentage increase in inflation. Taxpayers can take the higher of the “actual cost or Fair Market Value (FMV) as of the first day of the base year for any capital asset purchased before the base year of the cost inflation index. The indexation advantage is added to the calculated purchase price. The FMV is computed using a registered valuer’s valuation report.
Significance of CII in Long-Term Capital Gains
The CII concept of calculating long-term capital gains under Section 48 of the Income Tax Act of 1961.
Section 48 of the Income-tax Act requires a person to subtract the following two amounts from the value of the consideration received or accumulated on account of the transfer of capital assets in order to compute capital gains under the Income-tax Act:
- Expenses incurred as a result of the transfer of capital assets
- The cost of acquiring the support and, if applicable, the cost of improvements.
Furthermore, for long-term capital gains, the indexed cost of purchase and indexed cost of improvement of assets must be considered rather than the usual expenses. The indexed cost of acquisition and indexed cost of improvement amounts can be evaluated as follows:
Indexed Cost of Acquisition = Cost of Acquisition * [CII of the FY in the capital asset is transferred ÷ CII of the year in which investment is first held or for FY 2001-02, whichever is later]
Indexed Cost of Improvement = Cost of Improvement * [CII of the FY in the capital asset is transferred ÷ CII of the first year in which improvement took place]
Thus, to compute long-term capital gains, the indexed cost must be used instead of the original price, a process known as indexation. The goal of indexation is to provide relief to taxpayers due to economic inflation by allowing them to modify their asset costs in relation to an acceptable inflation indicator known as the Cost Inflation Index, or CII. As a result, the computed capital gains reflect the effects of inflation. However, there are specific circumstances in which indexation benefits are not permitted.
Things to Note About Cost Inflation Index in India
There are a few critical points that an assessee should keep in mind:
- When the asset is bought or received at the will of the assessee, then CII will be considered on the year the investment is received. In this instance, the purchase year of the support is to be ignored.
- Any development or improvement cost incurred before 1 April 2001 is not eligible for indexation.
- The benefits procured from indexation are not applicable for debentures or bonds.
How Can Indexation Reduce Tax Liabilities for LTCG for Assessments?
Because CII is used to compute the inflation-adjusted cost of asset acquisition for the calculation of LTCG, this indexation can aid in minimising tax liabilities on the same.
Assesses can reduce the amount of tax payable on long-term capital gains derived from the transfer of assets such as debt mutual funds, real estate, and so on by lowering their total invested amount in line with the CII of asset purchase and sale years.
For example, any gain realised by an assessee as a result of the transfer or sale of a property will be subject to capital gains taxes, whether long or short-term. If the holding duration of the property is less than 24 months, the gains from the transfer of these assets are deemed short-term capital gains and are not indexable.
However, if an assessee has owned an asset for more than 24 months at the time of sale or transfer, they are subject to a 20% tax with the CII application.
When CII is applied to property gains, the amount of profit is immediately lowered. As a result, the amount on which taxes will be levied will be reduced, lowering an assessee’s tax liabilities on LTCG.
This decrease in tax burden is one of the critical reasons for a rise in bond fund subscriptions and issuance of Fixed Maturity Plans (FMP). Thus, the application of CII on LTCG can leave assessees with a surplus after their long-term gain tax payments, which they can then use to invest in other financial assets.
Conclusion
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FAQ’S
What does CII mean in the context of income tax?
CII stands for Cost Inflation Index, which is used to calculate the indexed cost of acquisition for assets such as property, stocks, bonds, etc. The indexed cost helps in reducing the tax liability on the capital gains earned from the sale of these assets.
What is the cost inflation index for the fiscal year 2022-23?
The cost inflation index for the fiscal year 2022-23 is 317.
When was India's Cost Inflation Index introduced?
The Cost Inflation Index was introduced in India in the year 1981.
What is the formula for calculating the cost of indexation?
The formula for calculating the indexed cost of acquisition is as follows: Indexed Cost of Acquisition = Actual Cost of Acquisition x (CII for the year of sale/CII for the year of purchase)
What is the Purpose of CII?
The purpose of the Cost Inflation Index is to adjust the purchase price of an asset for inflation, so as to arrive at a more accurate capital gain when the asset is sold. By using the CII, the capital gains tax liability is reduced, which helps in incentivizing long-term investment.
What will the cost of inflation be in 2023?
It is difficult to predict the exact inflation rate for the year 2023. Inflation is influenced by various economic factors and can vary significantly over time.
What is the Cost of Inflation Index for the fiscal year 2021-22?
The cost inflation index for the fiscal year 2021-22 is 317.
What does CII mean in the context of income tax?
CII stands for Cost Inflation Index, which is used to calculate the indexed cost of acquisition for assets such as property, stocks, bonds, etc. The indexed cost helps in reducing the tax liability on the capital gains earned from the sale of these assets.
What is the formula for computing indexation cost?
The formula for computing the indexed cost of acquisition is as follows: Indexed Cost of Acquisition = Actual Cost of Acquisition x (CII for the year of sale/CII for the year of purchase)
How much is the cost inflation index for the year 2022-23?
The cost inflation index for the year 2022-23 is 331.
