Cost Inflation Index as per Income Tax Act

26 Aug 2021 15:22:38 Comment(s) By TAXAJ

Cost Inflation Index - Overview, Calculation & Benefits

Prices of goods increase over time, resulting in a fall in the purchasing power (quantity of goods that one unit of money can buy) of money. If two units of goods could be bought for Rs 100 today, tomorrow only one unit might be available for Rs 100 due to inflation. Cost Inflation Index (CII) is used to estimate the increase in the prices of goods and assets year-by-year due to inflation.

Why is Cost Inflation Index Calculated?

Cost Inflation Index is calculated to match the prices to the inflation rate. In simple words, an increase in the inflation rate over time will lead to a rise in the prices.

Who Notifies the Cost Inflation Index

The Central Government specifies the cost inflation index by notifying in the official gazette. 
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 cost of the same basket of goods and services in the previous year to calculate the increase in prices.

What is the Current Cost Inflation Index

Financial Year  Indexation
 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
 2020-21 301
 2021-22 317
 2023-24 348

How is Cost Inflation Index Used in Income Tax

Long-Term Capital Assets are recorded at cost price in books. Despite increasing inflation, they exist at the cost price and cannot be revalued. When these assets are sold, the profit amount remains high due to the higher sale price as compared to purchase price. This also leads to a higher income tax. The cost inflation index is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes to benefit taxpayers. To benefit the taxpayers, cost inflation index benefit is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes.

What is the concept of base year in Cost Inflation Index

The base year is the first year of the cost inflation index and has index value as 100. Index of all other years is compared to the base year to see the increase in inflation percentage. For any capital asset purchased before the base year of 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.

Why is the base year of Cost Inflation Index changed to 2001 from 1981?

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. So, for a capital asset purchased before 1st April 2001, taxpayers can take higher of actual cost or FMV as on 1st April 2001 as the purchase price and avail benefit of indexation.

Practical Examples

Case 1: Rahul purchased a flat in FY 2001-02 for Rs. 10,00,000. He sells the flat in FY 2017-18. What will be the indexed cost of acquisition?

In this case, CII for the year 2001-02 and 2017-18 is 100 and 272 respectively. 
Hence, the indexed cost of acquisition = 10,00,000 x 272/100 = Rs. 27,20,000 

Case 2: Shivani purchased a capital asset in FY 1995-1996 for Rs. 2,00,000. FMV of the capital asset on 1st April 2001 was Rs. 3,20,000. She sells the asset in FY 2016-17.What is the indexed cost of acquisition? 

Here, the asset is purchased before the base year. 
Hence the cost of acquisition = Higher of actual cost or FMV on 1st April 2001. i.e. cost of acquisition = Rs. 3,20,000. 
CII for the year 2001-02 and 2016-17 is 100 and 264 respectively. 
Indexed cost of acquisition = 3,20,000 x 264/100 = Rs. 8,44,800 

Case 3: Gita has purchased equity shares of Rs. 1,00,000 on 1st March 2015 and sells the shares on 1st April 2020. What will be the indexed cost of acquisition?

CII for the year of purchase FY 2014-15 is 240 and 
for the year of sale 2020-21 is 301
Hence, indexed cost of acquisition = Rs. 1,00,000 x 301/240 = Rs. 1,25,416


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