How Indexation can help you save Taxes
- February 19, 2022
- Posted by: MvM Team
- Category: Personal Finance
To understand the concept of Cost Inflation Index (CII), let us first understand what exactly inflation is.
Inflation is simply the increase in the general price level of goods and services like food or clothing. In simple words, when we say inflation is 5% per annum, it means the prices of goods and services have increased by 5% over the previous year.
Read more about Inflation here.
Cost Inflation Index (CII)
CII is a measure to quantify the extent of inflation with respect to the base year, 2001 in this case. It is very a very useful tool because investors can use CII to reduce their tax liability by factoring in inflation to their investments.
Indexation can be used to increase the cost of purchase of any asset thereby reducing the Long-Term Capital Gain (LTCG) Tax on the profit earned at the time of sale of the assets such as debt mutual funds, land and property, and certain other sovereign bonds.
Some special considerations:
– The cost of any relevant asset purchased before 1st April, 2001 will be consider the higher of:
a) Purchase price OR
b) The fair market value on 1 April, 2001
– The purchase price of any relevant asset transferred will be based on the fair market value on 1st April, 2001 or actual date of transfer, whichever is later.
Cost Inflation Index is given in the table below:
2001-02 | 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 |
Source: www.incometaxindia.gov.in
Let’s try and understand this with the help of an example
Assume that you invested an amount of ₹1 Lac in a debt mutual fund in June, 2016. You redeemed your units for ₹2 Lac in December, 2021. If not for indexation, your tax on long-term capital gain would have been:
₹20,000 (20% tax on profit of ₹1 Lac).
However, non-equity oriented mutual funds enjoy long-term capital gains tax at 20% with indexation benefit.
So, let’s see how much tax will you pay now:
Due to indexation, the cost of purchase will increase from ₹1 Lac to ₹1.2 Lac* thus reducing your profit to ₹80,000 from ₹1 Lac.
*Cost of purchase = (CII in year of purchase/CII in year of sale) × Actual purchase price
= (317/264)# × ₹1 Lac
= ₹1.2 Lac
#Value taken from the table aboveHence your capital gains will be ₹2 Lac – ₹1.2 Lac = ₹80,000.
And the tax that you will now pay will be ₹16,000, which is ₹4,000 less than what was paid earlier (₹20,000 – ₹16,000)[i] [i] Note: Figures have been approximated to make the calculations understandable
