Cost Inflation Index - All you Need to Know about CII

Example: Let’s say you purchased a piece of land in June 2012 (FY 2012-13) for Rs.1,00,000. The CII that year was 200. You sell the land in 2025 (FY 2025-26) for Rs.5,00,000, when the CII is 376.

1. Step 1: Adjust the purchase cost for inflation To account for inflation, multiply the original cost by the ratio of the CII of the sale year to the CII of the purchase year. Adjusted cost = 1,00,000 × (376 / 200) = Rs.1,88,000

1. Step 2: Calculate the capital gain Capital gain = Sale price – Adjusted cost Capital gain = 5,00,000 – 1,88,000 = Rs.3,12,000

1. Step 3: Benefit of using CII Without adjustment, the gain would have been Rs.4,00,000. Using CII reduces taxable gain to Rs.3,12,000, saving you tax on Rs.88,000.

What is the Purpose of Cost Inflation Index?

The Cost Inflation Index (CII), which allows for the derivation of a long-term capital asset.

It allows you to calculate capital gains on your assets using

1. property (real estate),

1. shares (market equities),

1. or certain other capital items like land, stocks, and patents.

The issue is that you always record the asset on your books at its original purchase cost. If you sell your asset years later, your profit account can show an inflated profit because the prices of assets go up.

The CII scales back the original purchase cost to its inflation-adjusted amount; therefore, you only pay capital gains tax on the real profit. Reducing the original amount of the cost reduces any potentially taxable gain, which reduces potential taxes.

In 2018, the Central Board of Direct Taxes or CBDT revised the CII with a new base year of 2001 rather than 1981, and their CII set for 2001 was 100, which brought the CII rates and calculations forward with fairer values, particularly when calculating revised cost bases on gains for assets acquired prior to 1981.

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

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

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.

Importance of Cost Inflation Index (CII)

The significance of Cost Inflation Index (CII) is as follows:

1. Ensures equitable taxation: Imposes tax only on the actual gain, realising that inflation must be accounted for even if this means nominal gains will not be taxed.

1. Mitigates long-term capital gains tax: When indexation applies, the cost base is increased, thus providing a lower taxable profit which immediately affects the tax obligation.

1. Provides clarity and consistency: Taxpayers and authorities now use an officially notified table of Cost Inflation Index providing a uniform methodology to determine gains and limits disputes over reasoning.

1. Facilitates historical asset valuation: CII is useful to accurately compute gains in situations when the asset was acquired a sizeable time ago, especially for holdings pre-2001, the base year for Cost Inflation Index.

1. Has application to inherited or gifted assets: CII uses the previous owner's year of acquisition to apply indexation, which remains equitable for taxation purposes. 

1. Assists in financial planning: Investors and their accountants can assess potential tax implications for long-term gains with accuracy.

1. Lawfully accepted: Cost Inflation Index is notified by the Central Government, thereby legally providing standing for taxation of long-term capital gains.

Benefits of Cost Inflation Index

The major advantages of having a Cost Inflation Index are as follows:

1. Lowers taxable capital gain: The legislation provides for a deduction of the indexed cost of acquisition or improvement (that is, using CII), reducing taxable long term capital gains from the full value of consideration.

1. Accounts for real economic gain: The ‘indexed cost’ accounts for inflation, where the cost base is adjusted for inflation through the use of CII, not taxation based on nominal rather than real economic gain.

1. Government approved and uniform: The CII table has been formally notified to the Gazette and is provided by the Income Tax Department. This ensures a legal,  acceptable, uniform way for taxpayers.

1. Easy calculation: The CII values in the official table provide taxpayers with an allowable standard factor for indexation, instead of taxpayers having to independently compute inflation.

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.