What is Indexation?
Indexation under taxation laws is a concept which allows a taxpayer to compute and tax only the real gains, after taking into account the increase in cost over a period due to inflation. For instance, if an asset is purchased at Rs. 100 at Year 0 and sold at Rs. 120 at Year 10 then for the income tax purposes gain is not Rs. 20. Instead, the cost shall be considered at Rs. 110 or 115 (depending upon the values in index table) and for the purposes of computing tax, gains shall be arrived at Rs. 120 less Rs. 110 or Rs 115 as the case may be.
To summarize, if a long-term capital asset is transferred by a taxpayer, the capital gains arising from such transfer is computed after deducting the indexed cost of acquisition instead of just cost of acquisition. Such indexation of cost of acquisition is done so as to reduce the tax burden of those taxpayers who have held a capital asset (i.e., investments, securities, house property, etc.) for a longer period. The indexation of cost allows a higher deduction in respect of cost of acquisition to neutralize the effect of inflation.
What is Cost Inflation Index?
The indexation of cost of acquisition is done on the basis of Cost Inflation Index (‘CII’) of the year in which a capital asset is transferred and of the year in which it was acquired. The CII is notified by the Govt. every year.
Cost of acquisition is multiplied with the CII of the year in which capital asset is transferred and divided by CII of the year in which asset is first held by the assessee or CII of 2001-02, whichever is later.
Formulae to Compute Indexed Cost
Cost Inflation Index since 2001-02
Below are the CII’s notified since 2001-02 by CBDT:
|Financial Year||CII||Financial Year||CII|
When is Indexation benefit not available?
The option to compute the indexed cost of acquisition is not available in the following cases:
- [Listed Securities] The benefit of indexation shall not be available in case of transfer of listed equity shares, units of equity-oriented mutual funds or units of business trust, if the resultant capital gain is a long-term capital gains taxable under Section 112A.
- [Bonds or Debentures] The scheme of indexation does not apply to any transfer of a bond or debenture. However, Capital Indexed Bonds issued by the Government and Sovereign Gold Bond issued by RBI are exceptions to this rule.
- [Securities held by Non-resident] Where a non-resident acquires shares or debentures of an Indian company in foreign currency, the scheme of indexation does not apply. Capital gain in such a case is computed in foreign currency and thereafter it is converted into Indian currency.
- [GDRs purchased in foreign currency] The scheme of indexation shall not apply in respect of GDRs (Global Depositary Receipts) purchased in foreign currency by a non-resident and resident individual.
- [Others] The benefit of indexation is not available in case of depreciable assets, slump sale and Offshore Funds and FIIs.