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Context

• The Income Tax Department has released the Cost Inflation Index (CII) for the fiscal year beginning April 2024.
• CII is used to calculate long-term capital gains from the sale of immovable property, securities, and jewellery.
• This adjustment helps in computing gains by considering inflation.

Cost Inflation Index (CII) Explained

• Purpose: The Cost Inflation Index (CII) is used to calculate long-term capital gains from the sale of assets, adjusting for inflation.
• Function: It helps taxpayers reduce taxable capital gains by indexing the sale price of assets to reflect current market values, considering inflation.
• Impact on Taxes: By indexing the purchase price of assets, the calculated profit (capital gain) appears lower, resulting in lower payable capital gains tax.
• Indexed Cost of Acquisition: When an asset is sold, the purchase cost is adjusted using the CII to reflect its inflation-adjusted value.
• Government Notification: The CII for a specific year is set and issued by the Government of India before the end of the fiscal year for tax calculation purposes.

Cost Inflation Index (CII) Calculation Formula for CII The Cost Inflation Index (CII) is calculated using the following formula:   Example Calculation Scenario: Purchase: Property bought for INR 40 lakhs in February 2001. Sale: Property sold for INR 65 lakhs in February 2010. Capital Profit Gain: INR 25 lakhs. CII Values: CII for purchase year (2001): 490 CII for sale year (2010): 686 Calculation: 1.CII Ratio: CII Ratio=686/490=1.40 2.Indexed Cost of Acquisition: Indexed Cost of Acquisition=40,00,000×1.40=56,00,000Indexed Cost of Acquisition=40,00,000×1.40=56,00,000 3.Long-term Capital Gain: Long-term Capital Gain=Sale Value−Indexed Cost of Acquisition 65,00,000−56,00,000=9,00,000 4.Tax Liability (20%): Tax Liability=20%×9,00,000=1,80,000 Without Indexation: Capital Gain: Capital Gain = Sale Value − Cost of Acquisition 65,00,000−40,00,000=25,00,000 Tax Liability (10%): Tax Liability=10%×25,00,000=2,50,000 Benefits of Using CII Using the Cost Inflation Index allows taxpayers to: Reduce Tax Liability: Indexing the purchase price reduces the apparent capital gain, thereby lowering the tax owed. Adjust for Inflation: It ensures the gain reflects the real increase in value rather than nominal gains due to inflation.

Why is the Cost Inflation Index Calculated?

• A Cost Inflation Index or CII is calculated to make the prices match the inflation charge. In other words, a rise seen in the price of inflation charge with time increases the cost.

Who Notifies the Cost Inflation Index (CII)?

• The cost inflation index is notified by the central government of the country that is indicated in the gazette.
• CII = 75% of the average increase in the cost of CPI X urban of the previous year
• Where CII is the cost inflation index and CPI is referred to as Consumer Price Index.

Important Note: CPI helps in comparing the recent cost of goods & services that indicates the economy along with the price of goods & services of the previous year, which helps calculate the rise in the cost.

Concept of the Base Year in the Cost Inflation Index

• Normally, a base year is referred to as the 1st year for CII and the value of the index is set at 100.
• The index value for every year is compared with a base year to check if there is an increase in the percentage of inflation.
• In case there is any kind of capital asset bought before a base year for CII, the taxpayer can then count the purchasing cost than the actual cost or as we term it ‘Fair Market Value’ considering it to be the first day of the start of a base year.

Current and Previous Cost Inflation Index Values

• Financial Year 2024-25: CII is 363
• Financial Year 2023-24: CII was 348
• Financial Year 2022-23: CII was 331

Implications of the Updated CII

• CII mirrors the inflation in the economy, reflecting the rise in prices of goods and services over time.
• For the fiscal year 2023-24, the CII was set at 348, and it has been increased to 363 for the fiscal year 2024-25, representing an increase of 15 points or an approximate annual inflation rate of 4.3%.
• This adjustment aligns with the retail inflation rate of 4.83% recorded in April 2024.
• Taxpayers usually prefer a higher CII as it enables them to claim larger tax rebates.

Usage of CII in Tax Calculations

CII has usefulness in adjusting capital gains for inflation.

This ensures that taxpayers are taxed on the real appreciation of assets rather than nominal gains caused by inflation.

Taxpayers can utilize the updated CII to calculate gains for long-term capital assets sold during FY 2024-25 and thereby reduce their tax liability.

Annual Notification Under Income-tax Act, 1961

• The CII is notified annually under the Income-tax Act, 1961.
• It is primarily used to calculate the "indexed cost of acquisition" for capital gains at the time of selling any capital asset.
• To qualify as long-term capital gains, assets generally need to be held for more than:

1. 36 months for most assets
2. 24 months for immovable property and unlisted shares
3. 12 months for listed securities

Purpose of the Cost Inflation Index

• The CII helps account for the rise in prices over time, which leads to a decrease in purchasing power.
• By using the CII, taxpayers can determine the inflation-adjusted purchasing price of assets, allowing for a more accurate computation of taxable long-term capital gains (LTCG).

PRACTICE QUESTION Q. Which of the following statements correctly describes the purpose of the Cost Inflation Index (CII) in the context of long-term capital gains? a) CII is used to calculate short-term capital gains from the sale of assets by adjusting for market volatility. b) CII is used to determine the current market value of an asset for financial reporting purposes. c) CII is used to calculate long-term capital gains from the sale of assets by adjusting for inflation. d) CII is used to set the purchase price of government securities in the primary market. Answer: c) CII is used to calculate long-term capital gains from the sale of assets by adjusting for inflation.

SOURCE: ECONOMIC TIMES