Cost Inflation Index (CII) is one kind of tool used to forecast yearly increase in the prices of goods and assets. The main reason behind increase in prices of Goods & Services is Inflation. Cost Inflation Index is measure of Inflation, used to calculate long term capital gains from sale of capital assets.
When purchasing power of a person get reduced and price of the products and services increased that phase is known as inflation.
For Example, if two units of goods could be bought for Rs 100 today, tomorrow only one unit might be available for Rs 100 due to inflation.
What is the Purpose of CII?
Cost Inflation Index (CII) is used to calculate the long-term capital gains from sale or transfer of capital assets. The term Capital Gains refers to profit received out of sale or transfer of any capital asset; and the term Capital Asset is inclusion of land, property, stock, bonds, jewellery, etc.
In accounting, normally assets are recorded in the books on the actual cost basis. Thus, despite rising prices of assets, these capital assets cannot be revalued.
Thus, at the time of sale of these assets, the profit or gain received out of it remains high due to their high sale price in comparison to their purchase price. As a result, assessee also needs to pay a higher income tax on the profit received out of these sales of assets.
With the application of Cost Inflation Index (CII) for capital gain, in the long run, the purchase price of assets is adjusted according to their sale price, leading to lower profits and eventually the tax amount also gets minimum.
Check out the below image for Computation of Capital Gains created by Taxofile;
Who notifies the Cost Inflation Index (CII)?
The CII is notified by the CBDT (Central Board of Direct Taxation) every year and as of now CBDT has notified Cost Inflation Index from F.Y. 2001-02 to 2020-21 (Earlier it was 1981-82)
Cost Inflation Index = 75% of the average rise in the Consumer Price Index* (urban) for the immediately preceding year.
*Consumer Price Index compares the current price of a basket of goods and services (which represent the economy) with the cost of the same basket of goods and services in the previous year to calculate the increase in prices.
What is the current Cost Inflation Index?
|Financial Year||Cost Inflation Index (CII)|
|2001-02 (Base year)||100|
Note: The Cost Inflation Index for the capital asset purchased before 2001-02 will remain 100 only.
What is meant by Base Year in Cost Inflation Index?
The Base year is the first year of the Cost Inflation Index and has index value as 100. Index of all other years is compared to the base year to see the increase in inflation percentage.
For any capital asset purchased before the base year of cost inflation index, taxpayers can take the purchase price as higher of the “Actual Cost or Fair Market Value (FMV) as on 1st day of the base year. Indexation benefit is applied to the purchase price so calculated.
Fair Market Value is calculated by the registered valuer and he mentions the same in valuation report.
Indexed Cost of Acquisition and Indexed Cost of Improvement
When indexation benefit is applied to Cost of Acquisition it becomes Indexed Cost of Acquisition.
When indexation benefit is applied to Cost of Improvement it becomes Cost of Improvement.
Image created by Taxofile expert will help you to understand the concept of Indexed cost of Acquisition and and Indexed cost of Improvement very easily.
To understand this entire concept just refer the illustration given by the Taxofile as follows;
Mr A purchased house property in the year 2002-03 for an amount of Rs 55,00,000 and now in the year 2020-21 he wants to sale the property to Mr B at Rs. 2,00,00,000. Find out Indexed Cost of Acquisition and Capital Gains.
As per the above case,
Cost of Acquisition = 55,00,000
Cost of Inflation Index in the year of purchase = 105
Cost of Inflation Index in the year of transfer = 301
Cost of Transfer = 2,00,00,000
Indexed Cost of Acquisition
= Cost of Acquisition * CII in the Year of Transfer / CII in the Year of Purchase
= 55,00,000 * 301 / 105
Calculation of Long Term Capital Gain : -
|(-) Indexed Cost of Acquisition||1,57,66,667|
|(-) Indexed Cost of Improvement||-|
|(-) Transfer Charges||-|