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Guide to Cost Inflation Index - Khatabook

A Complete Guide on Cost Inflation Index

by Khatabook

What is the Cost Inflation Index?

Why does the price of commodities seem to only increase over a period of time, and not decrease? Well, the answer is that it has got a lot to do with the purchasing power of money. A few years back, you were able to buy three units of goods for Rs 300, but today you may only be able to buy a single unit for the same price.
The thing that rules this change in the backdrop is inflation. The sustained hike in the price of goods/services and the decline in value of money is referred to as inflation. And the tool that helps in calculating the estimated annual increase in the price of goods due to inflation is termed as a cost inflation index.

The Cost of Inflation Index is an important parameter. It represents the inflation index in the country. The Central Government of India issues this index every year through its official gazette. This index forms a basis for measuring inflation and is covered under Section 48 of the Income Tax Act, 1961. 

What is the Purpose of Calculating the Cost Inflation Index?

The cost of inflation index is used for calculating long term capital gains. In simple words, it matches the price of assets to the inflation rate. The capital gain refers to profits achieved from the selling of capital assets such as property, stocks, shares, land, trademarks, or patents. For stipulating capital gain index, CII of the year in which you purchased the asset and the year in which you sold assets are taken into consideration.  

Generally, in accounting books, the long term capital assets are documented at their cost price. Thus, even after an increase in the price of assets, the capital assets cannot be reassessed. Therefore, during the sale of these assets, the profit acquired on them remains higher than the cost of purchase. As a consequence, you need to pay a higher income tax on the gains made. However, with the cost inflation index’s application, the purchase price of assets is revised as per their current sale price. This results in lowering down profits as well as the applicable tax amount.

Let’s Take An Example:

Suppose you purchased a property worth Rs 70 lakhs in the year 2014, and in the year 2016, you decided to sell it at Rs. 90 lakhs. Here the capital gain you made is of Rs 20 lakhs, so you can imagine how much tax you need to pay for this. Indeed, a significant share of your profit will go into tax.

Thus, to help people save from heavy tax payments, the government of India has introduced CII. Using CII, the purchasing cost of assets is indexed i.e.; It is raised from its original price as per the current inflation. Consequently, this brings down your capital gain as well as the tax payable on an asset sale.

How is the Cost Inflation Index Calculated?

If left to investors, then everyone would form a different perception regarding inflation meaning. Considering this, the Central Board of Direct Taxes, each year, issues a standard CII value based on the calculation on the consumer price index to calculate indexed Cost.  

Cost Inflation Index = 75% of the average increase in the Consumer Price Index for the previous year.

The consumer price index reflects the overall change in the price of a product with respect to its price in the base year. In budget 2017, new CII indices were introduced to be applicable from 2017-18 onwards. This revision involved the change of base year from 1981-82 to 2001-02.  The revision was done to mitigate the issues faced by taxpayers in the valuation of capital assets purchased on and before 1981. 

Cost Inflation Index Chart:

Given below is the revised cost inflation index chart for the last ten financial years.

Financial Year Cost Inflation Index
 2001 – 02 (Base Year) 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

What is the Significance of Base Year in CII?

The base year represents the first year in a series of financial indexes. The base year is fixed at an arbitrary index value of 100.  To assess the percentage inflation hike, the indexing of subsequent years is done in accordance with the base year.  

Moreover, for the capital assets acquired before the base year, taxpayers can choose to either select the fair market value as on the first day of a base year or the actual Cost for indexed cost and gain/loss computation.

How are Indexation Benefits Applicable?

When the CII index is applied to the asset purchase price (Cost of Acquisition), then it is termed as Indexed Cost of Acquisition. 

Following is the formula for calculation of indexed Cost of asset acquisition:

Cost Inflation Index 1

Following is the formula for calculation Indexed Cost of asset improvement:

Cost Inflation Index 2

Essential Things You Need To Know About Cost Inflation Index In India

For calculation of CII, there are few essential things that a taxpayer needs to keep in mind:

  • Indexation does not apply to capital improvement expenditures incurred on assets before April 1st, 2001.
  • In case of assets acquired in a will, CII shall be considered for the year in which assets are received. At the same time, the actual year of purchase should be neglected.
  • CII benefits exempt debentures, bonds except for the sovereign gold bonds or capital indexation bonds issued by RBI.

We hope, this guide proves instrumental in helping you understand and navigate all ins and outs of the cost of inflation index and its benefits.

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