Can you guess, what these numbers are for 200, 220, 240 or 264?
Don’t worry it is not some math thing. These numbers are used as measures to save you from paying higher taxes on the sale of any capital asset like real estate or gold. It’s the value of the “Cost Inflation Index” (CII) from the financial year 2012 – 13 to 2016 – 17.
Let’s understand what is this and how CII can be used to save tax?
What is the Cost Inflation Index?
Imagine you have bought a house in 2015 worth Rs. 2 Cr. and you are selling it for Rs. 3 Cr. in 2018. So, what will be the capital gain here? It is Rs. 1 Cr., can you imagine how much tax you might have to pay for it? That will be really a big chunk of the profit to be paid as tax.
To save you from heavy tax payments, the government has come up with CII. It is used for calculating the estimated increase in the prices of goods and assets year-by-year due to inflation.
With the help of CII, the cost of purchase of an asset will be indexed, in other words, it will be revalued or increased from its original price, considering the effect of inflation and will result in lowering capital gain tax payable on the sale of the asset.
How?? we will see later, but lets first understand…
Why CII is used in income tax?
CII is used for capital assets like real estate, gold, debt mutual funds or debentures. Asset class whose price will increase by a period of time as the value of money gets eroded due to the country’s inflation.
However, we record capital assets at cost price, despite increasing inflation, they exist at the cost price and cannot be revalued. Therefore, when these assets are sold, the profit amount remains high due to the higher sale price as compared to purchase price. This leads to a higher tax to be paid on capital gain arisen on their sale.
In the above-mentioned example, we all know that the value of 2 Cr. at the time of 2015 can not be equal to the value in the year 2018, it will be increased. The house purchased in 2 Cr. will cost much higher today, and the reason is “Inflation”.
And therefore, the Cost Inflation Index is calculated to match the prices to the inflation rate. In simple words, an increase in the inflation rate over a period of time will lead to an increase in the prices of capital assets and eventually result in lesser capital gain and tax.
In simple words, CII helps in calculating Real gain =
Selling Price of the Asset – Inflation Adjusted Purchase Price of Asset
How the cost inflation index is calculated?
How will you calculate the Inflation Adjusted Purchase Price? If let on investor, each person will have his own view in inflation, hence the CBDT (Central Board of Direct Taxes) notifies a unique number based on their calculation on consumer price index every year in the official gazette, which is used for calculating the indexed cost.
Cost Inflation Index = 75% of the average rise in the Consumer Price Index* (urban) for the immediately preceding year.
Consumer Price Index compares the current price of a basket of goods and services (which represent the economy) with the price of the same basket of goods and services in the previous year to calculate the increase in prices. How CII is calculated is not much of our use, but let us see, what are the rates notified?
What is the concept of the base year in the Cost Inflation Index?
For this purpose, the government has defined a base year i.e 2001 – 02. For all purchases before 2001, the factor used is the base factor which is 100.
Any capital asset purchased before the base year of the Cost Inflation Index, taxpayers can take the purchase price as higher of the “actual cost or Fair Market Value (FMV) as on 1st day of the base year. Indexation benefit is applied to the purchase price so calculated. FMV is based on the valuation report of a registered valuer.
Suppose a land was purchased in the year 1995. So, for calculating the indexed cost of acquisition, the fair market value of land in the year 2001 – 2000 will be considered for calculation of the indexed cost of acquisition.
Change of base year from 1981 – 82 to 2001 – 02?
Initially, 1981-82 was considered as the base year. But, taxpayers were facing hardships in getting the properties valued which were purchased before 1st April 1981. Tax authorities were also finding it difficult to rely on the valuation reports.
Hence, the government decided to shift the base year to 2001 so that valuations can be done quickly and accurately.
Chart of Cost Inflation Index
|Financial Year||Cost Inflation Index (CII)|
|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|
Applicability of CII in capital gain tax calculation
The cost inflation index can be used for calculating long term capital gains (LTCG) for investments in securities and real estate.
Since LTCG is flat 10 % (above the gain of Rs. 1 Lac) for investments in Equities, hence it has no relevance for calculating LTCG for investments in shares and equity mutual funds. But, it is useful to calculate LTCG in debt-oriented mutual funds (especially Bond funds and Fixed Maturity Plans).
Debt Mutual Funds – LTCG can be claimed only if the holding period is more than 3 years.
Properties / Real Estate – In the case of property, LTCG can only be claimed if the holding period is more than 2 years.
How CII is applied?
When the indexation benefit is applied to the “Cost of Acquisition” (purchase price) of the capital asset, it becomes “Indexed Cost of Acquisition”.
Calculation of Indexed Cost of Acquisition
Indexed Cost of acquisition = Cost of acquisition * CII for the year of transfer / CII for the year of purchase or base year (in case of the asset purchased before 2001)
Let’s understand this with the help of the same example given at the start. You bought a house for Rs. 2 Cr in the financial year 2015 – 16 and sold it in F.Y. 2018-19 for Rs. 3 Cr. So, what will be the capital gain after considering CII?
CII for 2015 – 16 = 254
CII for 2018 – 19 = 280
Indexed Cost of acquisition = 2,00,00,000 * 280/254 = 2,20,47,244
Therefore, Capital gain = Cost of sale – Indexed cost of aquisition = 79.52 Lakh (3 Cr. – 2.20 Cr.) which would have been Rs. 1 Cr.withour CII.
Hence, taxed at 20% (rate for LTCG) saved on Rs. 20.48 Lakh i.e Rs. 4 Lakh approx.
I hope, this article helped you in understanding the concept of CII and its importance. Let us know what you think about CII and revision made by CBDT in the base year in the comment section.