Cost inflation indexation benefit on LTCG

The long term capital gain (LTCG) made on assets such as shares, mutual funds, property, etc. is taxable if the asset is held for more than 36 months. The tax rate on LTCG is 20%, plus 3% cess and surcharge, which is applicable if the income exceeds Rs 50 lakh. If the asset is held for less than 36 months, the short term capital gains tax becomes applicable.

Now, during the holding period of 36 months or more, the rising inflation erodes the value of the investment made and, therefore, it negatively impacts the capital gain made on the asset. Hence, it is imperative that the increase in inflation is taken into account to nullify the negative impact on the value of the asset. To facilitate the adjustment in the cost of acquisition, that is, to increase the cost of acquisition in line with the increase in inflation during the holding period of the asset, the Ministry of Finance, Government of India, publishes the Cost Inflation Index (CII) for all financial years. Such indexation helps the taxpayer to increase the cost of acquisition of the asset and thereby reduce the gain made on the sale of the asset. Since the gain made on the asset is reduced, the tax liability on the LTCG is correspondingly reduced, depending on the financial year in which the sale was effected.

Here is the new CII published by the Central Board of Excise & Customs, Ministry of Finance.

Now, if an investor has purchased, say, debt fund units worth Rs 10,000 in May 2012 and sells the units in December 2017 at Rs 14,000, the LTCG is Rs 4,000. The investor can avail indexation benefit by calculating indexed gain as follows:

Hence, the tax on LTCG of Rs 4,000 is reduced to just Rs 82.40. Without indexation, the tax on LTCG would have been Rs 824!