What is cost inflation index (CII)?

The Cost Inflation Index (CII) is a measure used in India to adjust the purchase price of assets to account for inflation. This index is primarily used for calculating long-term capital gains on the sale of assets like real estate, stocks, bonds, and mutual funds. By adjusting the purchase price to account for inflation, the CII helps in reducing the tax burden on capital gains.

Key Points about Cost Inflation Index (CII):

1. Purpose:
   • The CII is used to adjust the cost of an asset for inflation between the year of purchase and the year of sale. This adjustment is necessary to determine the “indexed cost of acquisition” when calculating long-term capital gains, thereby ensuring that the taxpayer is taxed only on the real gains (i.e., gains after accounting for inflation).
2. How It Works:
   • The CII is released annually by the Central Board of Direct Taxes (CBDT) in India. The base year for the index was shifted to 2001-02, with the index value for that year set at 100. The CII value for each subsequent year reflects the level of inflation, with higher values indicating higher inflation.
   • When a person sells an asset, the purchase price is multiplied by the CII for the year of sale and then divided by the CII for the year of purchase. This gives the indexed cost of acquisition, which is then used to calculate the long-term capital gain.
3. Formula:
   • Indexed Cost of Acquisition = (Actual Purchase Price) × (CII for the Year of Sale) / (CII for the Year of Purchase)
   • Long-Term Capital Gain = Sale Price – Indexed Cost of Acquisition
4. Example:
   • Suppose you bought a property in the financial year 2005-06 for ₹10,00,000, and you sell it in the financial year 2023-24 for ₹50,00,000. The CII for 2005-06 is 117, and for 2023-24, it is 348.
   • Indexed Cost of Acquisition = ₹10,00,000 × (348/117) = ₹29,74,358
   • Long-Term Capital Gain = ₹50,00,000 – ₹29,74,358 = ₹20,25,642
5. Applicability:
   • The CII is applicable only for long-term capital assets, which are assets held for more than a specified period (usually 24 to 36 months depending on the asset type). It does not apply to short-term capital gains.
6. Tax Implications:
   • Using the CII reduces the taxable amount of long-term capital gains, which can significantly lower the capital gains tax payable by the seller. This adjustment reflects the principle that taxpayers should not be taxed on the portion of the gain that is merely due to inflation.
7. Annual Updates:
   • The CII is updated annually by the government, reflecting the inflation trends of the past year. Taxpayers and tax professionals need to stay updated with the latest CII values for accurate capital gains calculations.

Importance of CII:

The Cost Inflation Index is a crucial tool for taxpayers in India, ensuring that they are not overtaxed due to inflation when realizing long-term capital gains on their investments. It plays a significant role in the tax planning and financial management of assets.