Cost Inflation Index - All you Need to Know about CII

What is the Purpose of Cost Inflation Index?

A Cost Inflation Index table helps in calculating the long-term capital gains from the transfer or sale of capital gains. Any profit made from the sale or transfer of capital assets, such as property, shares, patents, land, and stocks, is referred to as capital gain. Long-term capital assets are typically recorded in books at their cost value in accounting.

Therefore, these capital assets cannot be revalued in spite of increasing asset prices. When these assets are sold, the profit or gain obtained from them at the time of sale is high. Assessees must therefore pay an increased tax on the profits from these assets. In the long term, the purchase price of assets is revised in accordance with the selling price through the use of the cost inflation index for capital gains.

This results in lower profits and a lower tax burden. The Central Board of Direct Taxes announced new Cost Inflation Index numbers for 2017–18 in February 2018. In this update, the old base year of 1981 was changed to 2001, with 100 being used as its CII. Additionally, the indices for succeeding years were updated appropriately.

To address the challenges faced by taxpayers in calculating the tax owed on gains from capital assets bought on or before 1981, the base year was revised.

New Cost Inflation Index Table from FY 2001-02 to FY 2024-25

Check cost inflation index for financial year's CII Value:

What is Base Year in Cost Inflation Index?

The base year is the index's first year, with a value of 100. To monitor the rise in the inflation percentage in the years after the base year, the indexation of those years is done according to the base year.

Assessees can use the higher of the asset's fair market value (FMV) and its actual cost on the first day of the base year to determine the purchase price for assets acquired prior to the base year of CII.

The benefit of indexation is then applied to the estimated asset purchase price. FMV, however, is determined using the asset's valuation report that was provided by a registered valuer.

Reason for the Base Year to Change from 1981 to 2001 

Earlier, the base year that was considered was 1981-1982. However, it was difficult for purchasers to get the base value of properties that was bought before April 1981. Therefore, the base year was changed from 1981 to 2001 so the accurate valuations can be done.

How to Calculate Cost Inflation Index?

The purchase price of the asset is indexed by the cost inflation index.

Example:

1. Suppose, you purchased an apartment for Rs.20 lakhs in Jan 2000 and sold it for Rs.35 lakhs in Jan 2009. Your profit or capital gain is Rs.15 lakhs.
   1. The CII for the year the apartment was bought in is 389.
   2. The CII for the year the apartment was sold in is 582.
   3. Then, The cost inflation index is 582/389 = 1.49
2. While computing tax, CII is multiplied with the purchase price to arrive at the indexed cost of acquisition. This is the actual cost of the asset.
   1. Therefore, the indexed cost of acquisition = 20,00,000 X 1.49 = Rs.29,92,288
   2. The long term capital gain= sale value of the asset- indexed cost of acquisition i.e., 35,00,00- 29,92,288 = Rs.5,07,712
   3. The tax liability if you use the indexation method is charged at 20 percent. The tax liability will be 20% X 5,07,712 = Rs.1,01,542
3. If you do not use the indexation method, the tax is liable at 10% on the capital gain. The capital in this case is sale price of the apartment - cost of acquisition = 35,00,000 - 20,00,000 = Rs.15,00,000. The capital gains tax is 10% X 15,00,000 = Rs.1,50,000.  

When you index, it helps you save taxes. It helps you adjust the purchasing price of the apartment with the current market prices.

How is Indexation Applied for Long-Term Capital Assets

Indexation is applied to the cost of asset acquisition in order to adjust asset prices in line with inflation. The formula for calculating the indexed cost of asset acquisition is as follows:

Indexed Cost of Asset Acquisition = (CII for the year of transfer or sale x Cost of asset acquisition)/CII for the first year of the asset's holding period or year 2001-2002, whichever occurs later

The formula to determine the indexed cost of asset improvement is as follows:

Indexed Cost of Asset Improvement = (CII for the year of transfer or sale x Cost of asset improvement)/CII for the year the asset improvement was made

How is CII Useful in Reducing Tax?

We saw in the earlier example that indexing helps us save a substantial amount of Income Tax that will be levied on the long term capital gain arising out of selling off your asset. But, indexation is not available for short term capital gain or losses. This benefit is also not available to Non-Resident Indians.

The indexation for long term capital gain is available only if you meet the following criteria:

1. Cost of acquisition of the asset has to be multiplied with the cost of inflation of the year it was transferred.
2. That figure is to be divided by the cost inflation index for the year in which the asset was acquired.
3. If the asset was purchased before 1981, the cost inflation index of the year 1981 must be taken into consideration.
4. If you have made improvement of the asset, then you need to adjust the cost inflation index with the multiplying with the CII of the year the improvement was made.

Things to Consider about Cost Inflation Index

Here are a few important considerations that assessees should make when determining their indexed cost of asset acquisition:

1. If an asset is acquired through an assessee's will, CII is taken into account for that year. The asset's actual purchase year is not relevant in this situation. 
2. Except for sovereign gold bonds or capital indexation bonds issued by the Reserve Bank of India (RBI), the benefits of indexation cannot be applicable to debentures or bonds.
3. Any improvement costs incurred prior to 1 April 2001 are not eligible for indexation.

How Can Indexation Lower Assesses’ Tax Liabilities on LTCG

Assesses can adjust their total invested amount according to the CII of asset purchase and sale years to reduce the amount of tax that is applied to long-term capital gains obtained from the transfer of assets such as real estate and debt mutual funds. Whether long-term or short-term, any gain that an assessee obtains from the transfer or sale of a property will be subject to the applicable capital gains taxes.

Gains from the transfer of these assets qualify as short-term capital gains and are not subject to indexation if the holding period of the aforementioned property is under 24 months.

Assessees, on the other hand, are subject to a 20% CII tax if they have owned an asset for over 24 months at the time of sale or transfer. Gains from property are subject to CII, which automatically lowers the amount of profit.

Therefore, the amount on which taxes will be imposed will also be decreased, lowering the assessee's tax obligations on LTCG. One of the main causes of a surge in subscriptions and issuance of bond funds and Fixed Maturity Plans (FMP) is this decrease in tax liability.

After paying their long-term gain taxes, assessees may still have funds left over after the implementation of CII on LTCG. These funds can be used to make investments in other financial instruments.

Removal of Indexation Benefit

The government has eliminated the indexation benefit with effect from 23 July 2024, on long-term capital gains. As a result, investors can no longer adjust the purchase price of their assets for inflation when calculating capital gains tax. This change may lead to higher taxable gains and increased tax liability.

For land or buildings acquired before 23 July 2024, taxpayers can choose between:

1. A 12.5% tax rate without indexation, or

1. A 20% tax rate with indexation.

However, for land or buildings purchased on or after 23 July 2024, a 12.5% tax rate without indexation will apply to long-term assets.