Cost Inflation Index (CII) and its Impact on Economy
Concept of Cost Inflation Index (CII)
Cost Inflation Index (CII) is the unit of money that is calculated every year for comparing the price rise rate of goods and services between current year and previous year. Price rise or inflation is a major tool for a country's economy to know if it is flourishing or lagging. It happens always that a bag of 10 fruits with a price of INR 100 today may change to a bag of 5 fruits with the same price a few days later - a result of inflation. Thus, Cost Inflation Index plays a role to track the inflation rate in order to keep a proper balance with purchasing power of consumers.
Notification of Cost Inflation Index (CII)
Central Board of Direct Tax (CBDT) is responsible to calculate the Cost Inflation Index, a unique 3-digit number, as defined u/s 48 of IT Act, 1961 and publish as a notification in Official Gazette.
In order to revise the base year for computation of capital gains, section 55 of the Income Tax Act, 1961 was amended vide Finance Act, 2017. Cost inflation index for Long Term Capital Assets sold after 01.04.2017 as notified by CBDT Notification No. 44/2017 dated 05.06.2017.
The chart below shows the Cost Inflation Index from FY 2001-02 (base year) till FY 2020-21:-
|Financial Year||Cost Inflation Index|
CBDT has notified Income Tax Cost Inflation Index for FY 2020-21 or AY 2021-22 vide Notification No. 32/2020-Income Tax dated 12th June 2020 at 301. As per the notification published in Gazette of India, by Government of India, Ministry of Finance (Department of Revenue), Central Board of Direct Taxes, the prescribed CII shall come into force with effect from 1st day of April, 2021 and shall accordingly apply to the AY 2021-22 and subsequent years.
Importance of Cost Inflation Index in Tax Calculation
Cost price of any capital asset is considered as the Recorded Cost Price in Books. This cost price of capital asset remains unchanged, although the selling price rises due to inflation. The price rise accounts for larger tax liability for the taxpayer over the higher gain margin on Long-Term Capital Assets, in the year the asset is sold. To give a relief, Cost Inflation Index is used to calculate the index price of the asset, where the purchase price of the capital asset increases, lowering down the capital gain value for the long-term capital asset and thus reduces the tax liability. This is the indexation benefit for the taxpayers having an income from Gains on Long-Term Capital Assets.
General Rule to calculate the Indexed Price of long-term capital asset is:
Indexed Price of asset =
Cost Price of asset x Cost Inflation Index for the year of transfer ¸
Cost Inflation Index for the year of Purchase
Note: The capital asset that is held for more than 36 months is considered to be long-term capital asset.
Mr Krishna Gopal bought a capital asset on FY 2011 in INR 3,00,000. In 2020, he sells it in INR 10,00,000. Transfer expenses on this sale is INR 24,000. Find the tax relief that Krishna Gopal obtains out of CII.
Here, as the asset is owned for more than 36 months, it is taken to be long-term asset and accordingly, the gain on its sale will be Long-Term Capital Gain.
Now, Selling Price of the asset (on FY 2020) = INR 10,00,000
Less, Transfer expenses - INR 24,000
Considered Selling Price = INR 9,76,000
Cost Price (on FY 2011) = INR 3,00,000
Taxable Capital Gain (with actual values) = INR 9,76,000 - INR 3,00,000
= INR 6,76,000
Let's calculate the Indexed Price of the asset:
Cost Inflation Index on Year of Purchase 2011 = 184
Cost Inflation Index on Year of Transfer 2020 = 301
Indexed Price of asset = INR 3,00,000 x 301 ¸ 184 = INR 4,90,761.00
Taxable Capital Gain (with indexed price) = INR 9,76,000 - INR 4,90,761.00
= INR 4,85,239.00 (lower taxable value)
Thus, Mr Krishna Gopal gets the indexation benefit on his income over Capital Gains.
Significance of Base Year in Cost Inflation Index
Base Year is the beginning year in which the Cost Inflation Index is computed and its value is taken to be 100. Succeeding years' inflation indexes are compared with respect to the Base Year's Cost Inflation Index value to find the inflation percentage. In case, an asset is owned before the Base Year of Cost Inflation Index, its purchase price can be considered as higher to the Actual Price or Fair Market Value (FMV) of the asset as outlined on the 1st day of the Base Year.
Deepak Varshney bought a flat in 1999 in INR 20,00,000. FMV of this capital asset on 1st April, 2001 was INR 24,50,000. He sells his flat in 2020. Find the indexed price on which his capital gain will be computed.
Here, the asset is owned for more than 36 months and so its income will be Long-Term Capital Gain. Since, the flat was bought before the Base Year 2001, its purchase price will be computed as higher to the actual price or FMV as on 1st April, 2001, i.e., INR 24,50,000.
Cost Inflation Index of Base year 2001 = 100
Cost Inflation Index on Year of Transfer 2015 = 301
Indexed Price of asset = INR 24,50,000 x 301 ¸ 100 = INR 73,74,500/-
Initially, 1981-82 was considered to be the base year of Cost Inflation Index, which later changed to 2001 due to the difficulty faced by both taxpayers and IT Department in determining the valuation of assets. Now, the purchase price of any asset bought before 1st April, 2001 can be taken to be higher than the actual price or FMV applicable on this date.