Capital Gain Index

To understand the capital gain index, first, it is important to understand what is a capital gain and the crucial concepts that are associated with it.

Capital gains can be described as gains that have been generated through the sale of capital assets. Proceeds earned through such transactions can arise either through investments in real estate or investment in securities.

Based on the holding period of capital assets, the proceeds generated through their sales can either be long-term or short-term.

If individuals hold onto assets like equities, preference shares, UTI units, zero-coupon bonds and equity bonds for over a year, they would be treated as long-term capital assets.

Besides them, all other types of assets when held for more than 36 months would be treated as long-term assets.

Capital Gain Index Calculation

The gains earned on long-term capital assets would be regarded as long-term capital gains and attract a tax known as a capital gain tax on them.

When it comes to estimating a sum of capital gains to be generated from a future sale, individuals need to adopt a systematic approach for capital gain index calculation.

What is Indexation?

Indexation is a systematic process that enables individuals to protect their earnings against tax erosion.

The process allows individuals to adjust the cost of investment for inflation with the help of a price index.

Indexation operates by taking into account the prevalence of inflation in the investment market. It allows individuals to increase their cost of assets to acknowledge the impact of inflation over the years.

Through indexation, investors not just learn to take into account the rate of inflation; they further learn to lower their tax liability. It will directly help investors to protect their capital gains against erosion.

When it comes to Mutual Funds, the Cost of Inflation Index plays a vital role to help index the cost of acquisition.

This makes it vital for investors to familiarise themselves with the concept of Cost of Inflation Index.

Indexation and Debt Funds

Being categorized as ‘income’ under a financial balance sheet, long-term capital is liable for taxation. Investors can use indexation to calculate the rate of tax on long-term capital gains generated through investments that were held for over 36 months.

Debt fund investors do not need to pay tax on their entire amount of capital gain. Investors would be able to reduce the value of their long-term capital gains and would be able to improve their earnings.

To understand how such an outcome is achieved, individuals need to familiarise themselves with the concept of cost inflation and its effect on capital gains.

Concept of Cost Inflation Index and Capital Gain

The rate of inflation tends to increase over the years. Therefore, it is a wise decision to take the same into account while estimating one’s tax liability and trying to build an index cost for capital gain. 

Typically, the Cost inflation Index (CII) is a measurement of inflation. Long-term capital gain index calculation is done by using the latest Cost inflation index prepared by the Government of India.

It helps to calculate the index cost for capital gain. In other words –

To calculate the long-term capital gains, individuals need to find out the indexed cost of an asset in question.

An intending seller would have to multiply their property’s cost of acquisition with the cost inflation index set for the financial year (the year when the transfer is to be made).

The numerical figure then achieved would have to divide by the CII number that was set for the year of purchase.

For example,

If Mr X bought a housing property on August 7, 2004 for Rs. 30 Lakh and sold it on April 6, 2018, for RS. 85 Lakh, the indexed cost of acquisition would be –

(Cost of acquisition x CII at the time of sale)/ CII at the time of purchase

(Rs 30 Lakh x 280)/113 = Rs. 74.33 Lakh

Therefore, the capital gain would be Rs. (85 – 74.33) Lakh = Rs. 10.67 Lakh

The Cost inflation index table below would help to calculate the index cost for capital gain.

It will also aid in finding out the difference in the rate of inflation that has been dominant in our economy for more than a decade.

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

2020-21

301

2021-22

317

2022-23

331

2023-24

348

Benefits of Indexation in a Nutshell

The difference between the cost price of an investment and its current market value is the amount of capital gain an individual would accrue in the event of a sale.

Here are a few benefits of indexation of a capital gain that individuals can avail themselves–

  • With the help of indexation, individuals would be able to estimate the impact of inflation on their debt funds and would be adjusting its cost price accordingly.
  • Individuals would be effective in reducing their share of long-term capital gains. Eventually, bringing down their taxable income.
  • Through indexation debt funds investors would be able to earn better returns than the FD holders as it makes debt funds more tax-efficient. The Fixed Deposit holders would be paying a higher amount of tax as the amount of interest accrued on an FD is added to the aggregate income of an individual and taxed as per their income tax slab.

For example, individual A creates an FD of Rs. 15,000 at a rate of 8%, by the end of 5 years –the maturity value would stand at Rs. 22,040 and the interest accrued on it would be a sum of Rs. 7,040.

Now suppose, individual A falls under the lowest tax bracket of 10%, a tax amount of Rs. 805.37 would have to be paid by A plus other surcharge and cess.

The tax incurred on FD would be higher than what would be incurred on a debt fund after indexation.

Make sure to use the cost inflation index to be able to make accurate capital index calculation. Besides the accuracy, it will further offer individuals the opportunity to make provisions for inflation and devise strategies to lower their tax liability on capital gains.

However, to be able to make the most of the CII, individuals need to be aware of the current index rate for capital gain and refer to the latest Cost of Inflation Index.

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