This post will discuss the meaning and tax implication of cost inflation index.
Meaning
Value of money is essentially what money can buy. Inflation refers to a scenario wherein same amount of money can buy lesser quantity for the same item. This happens due to surge in price of items. In simple terms, cost inflation index (CII) is used to estimate this price rise in goods and assets over the years due to this inflation.
Tax Implications
Gain on sale of an asset is understood as difference of sale price and purchase price of an asset.
However, for most long term capital assets, a part of gain of sale of asset is attributed to inflation. For example if a land was purchased in the year 2000 for Rs. 10 lakhs and is being sold in the year 2020 for Rs. 1 Crore, the entire gain of Rs. 90 lakhs is not a capital gain. A portion of it is considered as gain on account of inflation which is calculated using cost inflation index.
In the above example, considering cost inflations index, the value of land in 2020 is considered as 30.1 lakhs (after adjusting for cost inflation). Hence, capital gain with be calculated as
Rs. 1 Crore - Rs. 30.1 lakhs = Rs. 69.9 lakhs
Tax implications are then applied on the capital gain portion and not on gain due to cost inflation, resulting in lower taxation.
While the above discussion deals in basic concept of cost inflation and its tax implication, there are several practical aspects that need detailed discussion and analysis. You may book a consultancy session with our experts for more details.
Cost inflation index (CII) for the last 21 years are provided below:
What if my capital asset was purchased prior to 1st April 2001
If your long term capital asset was purchased prior to 1st April 2001, fair market value of asset as on 1st April 2001 is considered as the purchase price (including improvements), ignoring the actual purchase price. Using this fair market value, the current indexed price is calculated. For all improvements post 1st April 2001, the same is considered on actuals.