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The value of any currency in an open market does not always remain the same, in shorter span, it fluctuates in a day’s course and in a longer-term it gradually grows as compared to other currencies. In such a scenario, as the value of the currency increases, the prices of various goods and services in a country also increases, which brings down the purchasing power of the money. Let’s say if we can buy 5 quantities of a certain product for ₹ 500 today, we might be able to buy just 4 of them over the period of 6 months or more due to the price inflation over the same period of time. 

The inflation plays its part in almost everything we do, it makes us pay more for the routine utilities over the years and at the same time, it might ease the capital gain tax which is due once an asset is bought or sold after retaining it for over 3 years. The capital gain tax is the most sought-after tax in the country as the properties and investments in properties attract a lot of money in the country as compared to other investment instruments.

What is the Cost Inflation Index?

The Cost Inflation Index (CII) can be described as the measure of increase in prices of basic goods and services being provided in the country popularly known as inflation. The value which is calculated here is used in computation of long-term capital tax and other important taxes related to the sale of assets within the country. 

To get into more details, regarding the inflation theory, as the price of the capital asset will rise in the coming years, the owner of the asset would gain a significant capital at the time of selling the same. Since the government levies a tax on such transactions, the owner would be required to pay a hefty sum as tax. In order to avoid paying a large sum towards the taxes, the sale price of the asset can be indexed to demonstrate the asset’s value as per its current value, taking into account inflation reducing its value. In this manner, the profit derived from the sale would be lower, thus reducing the capital gains payable.

To save you from heavy tax payments, the government had come up with the CII. It is used for calculating the estimated increase in the prices of goods and assets year-by-year due to inflation. With the help of CII, the cost of purchase of an asset will be indexed, in other words, it will be revalued or increased from its original price, considering the effect of inflation and will result in lowering capital gain tax payable on the sale of the asset.

Cost Inflation Index in terms of Income Tax in India –

CII is majorly calculated for the strong capital assets like Real Estate, Gold, Debt Mutual Funds or Debentures issued by public companies or government organizations. All the asset classes whose price will inflate in a period of time as the value of money gets eroded due to the country’s inflation. However, we record the capital assets at the cost price, the price at which they were bought, despite inflation going up, they exist at the cost price and cannot be revalued any further. Therefore, when these assets are sold, the profit amount remains high due to the higher sale price as compared to purchase price or cost price. This leads to a higher tax to be paid on capital gain realised on the sale of the asset.

In the above-mentioned example, we all know that the value of ₹ 1 crore during the year 2015 cannot be equal to the value or will never be equal to the value in the year 2018, it will be higher than the previous cost. The house purchased at ₹ 1 crore will cost much higher today, and the reason is justified under the term “Inflation”.

And therefore, the Cost Inflation Index is calculated to cope up the prices to the rate of inflation. In an easier approach, an increase in the inflation rate over a period of time will lead to an increase in the prices of capital assets and eventually result in lesser capital gain and tax.

How is the Cost Inflation Index calculated?

The basic procedure to calculate the ‘Inflation Adjusted Purchase Price’ is essentially simple and can be apprehended by one and all. However, if it is left on the investors to calculate, every other assessee will have his own view in inflation, hence the CBDT (Central Board of Direct Taxes) calculates a unique number based on their algorithms for consumer price index every year in the official gazette, which is used for calculating the indexed cost.

[ Cost Inflation Index = 75% of the average rise in the Consumer Price Index* (urban) for the immediately preceding year]

Consumer Price Index contemplates and considers the current price of a basket of specific goods and services (which are represented as the necessities in the economy), and then compares them with the price of the same or similar basket of goods and services produced in the previous year to calculate the increase in the prices of the goods. How CII is calculated is not much of our use, but let us see how these rates which are calculated are presented and can be used for various other tax calculation measures.

What can we understand from the Old and New CII?

Indexation table for the Old and New CII as provided by the Government of India;

Current CII – 

Cost inflation index for Long Term Capital Assets sold after 01.04.2017 as notified by the Central Board of Direct Taxes bearing Notification No. 44/2017 dated 05/06/2017 –

Financial Year	Assessment Year	Cost Inflation Index
2001-02	2002-03	100
2002-03	2003-04	105
2003-04	2004-05	109
2004-05	2005-06	113
2005-06	2006-07	117
2006-07	2007-08	122
2007-08	2008-09	129
2008-09	2009-10	137
2009-10	2010-11	148
2010-11	2011-12	167
2011-12	2012-13	184
2012-13	2013-14	200
2013-14	2014-15	220
2014-15	2015-16	240
2015-16	2016-17	254
2016-17	2017-18	264
2017-18	2018-19	272
2018-19	2019-20	280
2019-20	2020-21	289
2020-21	2021-22	301*

ON or AFTER 01/04/2017

In a bid to revise the base year for the computation of Capital Gains, under the Section 55 of the Income Tax Act, 1961, the same was amended with the presentation of the Finance Act, 2017 in order to provide, that the cost of acquisition of an asset acquired before April 1st 2001 shall be allowed to be taken at fair market value as on 1st April, 2001 and the cost of improvement shall include only those capital expenses which are incurred after the same date.

Old CII –

Financial Year	Assessment Year	Cost Inflation Index
1981-82	1982-83	100
1982-83	1983-84	109
1983-84	1984-85	116
1984-85	1985-86	125
1985-86	1986-87	133
1986-87	1987-88	140
1987-88	1988-89	150
1988-89	1989-90	161
1989-90	1990-91	172
1990-91	1991-92	182
1991-92	1992-93	199
1992-93	1993-94	223
1993-94	1994-95	244
1994-95	1995-96	259
1995-96	1996-97	281
1996-97	1997-98	305
1997-98	1998-99	331
1998-99	1999-2000	351
1999-2000	2000-2001	389
2000-01	2001-02	406

 

Financial Year	Assessment Year	Cost Inflation Index
2001-02	2002-03	426
2002-03	2003-04	447
2003-04	2004-05	463
2004-05	2005-06	480
2005-06	2006-07	497
2006-07	2007-08	519
2007-08	2008-09	551
2008-09	2009-10	582
2009-10	2010-11	632
2010-11	2011-12	711
2011-12	2012-13	785
2012-13	2013-14	852
2013-14	2014-15	939
2014-15	2015-16	1024
2015-16	2016-17	1081
2016-17	2017-18	1125
2017-18	2018-19	272
2018-19	2019-20	280

As you might have observed, with the base rate earlier, the calculated Cost Inflation Index was providing a higher number, which resulted in revenue declination for the Government of India as the assets which were being sold or purchased at that rate were taking a huge capital as profits but with the capital gain tax being calculated according to the previous base rate were comparatively low.

What is the significance of the Base year in the CII?

The Government of India provides a specific calendar year as the base year, and appropriately calculates the CII beginning from the base year. To work out the rise in inflation percentage, index of other years is compared to the base year for every particular year. Finance Minister, Arun Jaitley, during his tenure announced the change in base year from 1981 to 2001.

For the purpose of computing and applying long term capital gains on the property, the property seller is supposed to calculate the indexed cost of purchasing the property. To appraise the indexed cost, the seller needs to multiply the property's cost of acquisition with the cost inflation index, as notified by the tax authorities for the year of transfer of power from one owner to another. This figure then has to be divided by the cost inflation index of the year of purchase but should the property be purchased prior to the base year of cost inflation index; one needs to know the property's fair market value for the base year. Hence, the base year is one of the most significant prospects of the Cost Inflation Index.

How can we calculate the Cost of Acquisition using CII?

One can easily calculate the actual cost of acquisition in the comforts of their couches and need not to worry about the miscalculations or over-calculation of the taxes associated with it. For this simple calculation, one needs to follow a two-step approach for the same;

 Step I

One needs to be aware of or calculate the actual cost of acquisition of the capital asset which is under consideration. For example, let’s say the cost of the asset as on date is ₹ 1 crore in an open market.

Step II

Take the values of the Cost Inflation Index of the year when the asset was transferred and divide it with the Cost Inflation Index of the year when it was actually purchased.

If in case the asset was acquired before the financial year 2001-02, the Index value for the year 2001-02 is to be used in the place of that year’s index (as prescribed by the Government of India under section 55 of the Income Tax Act of India, 1961).

Then, the coefficient calculated by these two indexes of the year of purchase and the year of sale, multiply it with the value of the asset as on date.

Calculation: -

Indexed cost of acquisition = Cost of Acquisition X {CII (for the year it is being transferred) / CII (for the year it was first held)}

Let’s suppose that the asset was first held in the year 2002-03 and is being transferred in the year 2018-19. Then the calculation would be like;

Indexed Cost of Acquisition = 1,00,00,000 X [280 / 105]

Indexed Cost of Acquisition = 1,00,00,000 X [2.6666]

Indexed Cost of Acquisition = ₹ 2,66,66,000/= (for the year 2018-19)

Computation of other Capital Gains –

Indexed Cost of Improvement:

The indexed cost of Improvement is very much similar to the cost of acquisition as described earlier. This can be taken into account if in case the assessee has incurred expenses for the improvement or maintenance of the asset. This is calculated other than the actual Indexed cost of acquisition.

Indexed cost of Improvement = Cost of Improvement X {CII (for the year it is being transferred) / CII (for the year it was improved)}

Capital Gain on an asset:

The capital gain on any asset can be easily accessed by computing the Indexed cost of acquisition and the Indexed cost of improvement and comparing it with the selling price of the asset as on the date of acquisition or sale.

Capital Gain = Net selling price of the asset – (Indexed cost of acquisition + Indexed cost of improvement)

Consider the following table to get more insights about how this calculation works in various scenarios;

Description	Value
Year of Purchase of the asset	2002-03
Purchase price of the asset	₹ 1 crore / ₹ 1,00,00,000
Year of Improvement of the asset	2009-10
Cost of Improvement	₹ 10 Lakh
Year of the sale of the property	2018-19
Selling Price of the property	₹ 3 crore / ₹ 3,00,00,000
CII for 2002-03	105
CII for 2009-10	148
CII for 2018-19	280

Calculation: -

Scenario 1: When the individual himself does the purchase and sale:

Indexed cost of acquisition = 1,00,00,000 x (280/105) = ₹ 2,66,66,000/-

Indexed cost of improvement = 10,00,000 x (280/148) = ₹ 1,89,189/-

Capital Gains = 3,00,00,000 – (2,66,66,000 + 1,89,189)

                       = 3,00,00,000 – 2,68,55,189 = ₹ 31,44,811/-

Scenario 2: When the purchase and transfer are carried out by third party other than the prime owner:

If the property is transferred from one person (as a gift, under a will or inheritance) to someone else, the procedure of computing the gains will be the same, but the gains will be received and realised by the new owner and not the prime owner of the asset.

Indexed cost of acquisition = 1,00,00,000 x (280/105) = ₹ 2,66,66,000/-

Indexed cost of improvement = 10,00,000 x (280/148) = ₹ 1,89,189/-

Capital Gains = 3,00,00,000 – (2,66,66,000 + 1,89,189) = ₹ 31,44,811/-

Scenario 3: When the asset under consideration is purchased before the financial year 2001-02 and the transfer is done on or after 1st April 2001:

When a particular asset is purchased before the base year as specified by the tax authorities in the country, the cost of acquisition of the asset is taken at the fair market value of the asset in that base year and the CII for the year of purchase is taken as CII for the base year. In the example discussed earlier, let us assume that the fair market value of the property in 2001-02 is ₹ 2,00,00,000/=

Indexed cost of acquisition = 2,00,00,000 x (280/100) = ₹ 2,80,00,000/-

Indexed cost of improvement = 10,00,000 x (280/148) = ₹ 1,89,189/-

Capital Gains = 3,00,00,000 – (2,80,00,000 + 1,89,189) = ₹ 18,10,811/-

The clear difference between the Indexed cost of acquisition of an asset purchased before the base year and the one purchased after the base is quite significant. The same amount can make a lot of difference in the tax payable at the time of transfer of property from one person to another. 

How can we use the Cost Inflation Index in the reduction of tax?

The CII has been in use since the 80s and has proved out to be an index of taxes on capital gains from sale of various assets. The Cost Inflation Index increases the purchase price of an asset, thereby reducing the scope of capital gains in the present situation. This reduction that takes place in the capital gains reduces the amount of tax payable on the transfer of property. Also, the inclusion of the cost of improvement will further reduce the capital gains resulting in lesser tax liability. This method of indexation using the cost inflation index is very beneficial if you want to reduce the tax on capital gains.

However, the cost can only be reduced once the assessee clears the criteria as follows:

• Cost of acquisition is to be multiplied by the Inflation Index for the year of transfer
• Indexed cost of acquisition for the year of transfer must be divided by the inflation index of the year it was originally purchased
• The asset purchased before 1981, must be averaged at 1981 as their base year
• In case of additional improvements, the cost must be indexed at the rate provided for the year of improvement