How You Can Use The Cost Inflation Index Effectively For Capital Gains

The use of the Cost Inflation Index is an important part of the tax calculation process, as this ensures that the cost price of various long-term capital assets increase during the calculation of capital gains.

The Cost Inflation Index is meant to give relief to the taxpayer due to the impact of inflation in the economy. The important thing is that its use is not just to calculate the tax to be paid at the time of filing the tax return, but even before that.

It helps the taxpayer to understand the kind of gains that would be generated and how to plan on saving tax before the end of the financial year. 

Number Declaration

The declaration of the CII is done quite early during the financial year and this gives enough time for those who are booking capital gains, to ensure that they are able to undertake tax planning properly.

For example, for fiscal 2024, the CII has already been declared at 348 and this is a rise from the level of 331 seen a year earlier. In percentage terms, the rise in the last one year is 5.1%. Even the rise in the CII during FY23 from the previous year was just 4.4%. This means that any capital gain that is made during the current financial year can be checked, by using the relevant CII number of the year of purchase and sale of the asset.

For example, the cost of a property bought in FY12 for Rs 30 lakh will become Rs 56.74 lakh for tax calculations in FY24. (30 lakh x 348 [CII of sale year]/184 [CII of purchase year]).

The rise in the value of the index number has to be seen not just over the previous year's figure, but also over a longer time frame because this will help one to understand the extent of the rise in the cost that they will be able to factor in to their calculations for various long-term assets.

Type Of Assets

The use of the CII is possible only for assets where there is long-term capital gains. Some of the common assets that are under this coverage include house property, gold and also those debt funds where the equity component is between 35% and 65% during the year.

The impact of the usage of CII will be different according to the asset because if this is being used for hybrid funds, then the change in the index number can be significant as it can ensure that a large percentage of the return of the fund is made tax-free.

Similar would be the case with an asset like gold or silver, where a part of the return would become tax-free for the investor. There are also times when the impact of the CII calculation is not very high, and this happens for various house property purchases where the cost price as a percentage of the sale itself is very small.

Before Sale

While most people tend to focus on this at the time of the payment or calculation during the tax return, it is important that there is a working done using the CII before the sale of the asset.

Since the CII for the year is known before the end of the financial year, it is possible for individuals selling any asset to ensure that they have the required working about the asset being sold.

At this time itself, if the calculation is done to see the impact of the taxation, then two things can be done. One is that very clearly, it will give an idea to the individual about the tax that they will have to pay, and then they can plan if they want to save the tax by making other investments or if they would like to pay the tax and close the matter.

The other thing is that this can also help them to reverse calculate the sale price that they need, so that after tax they end up with a specific amount. This will, at least, make sure that the individual is able to get the money that they want by the sale of the asset. The larger the value of the asset, the higher the importance of this calculation.

Arnav Pandya is founder at Moneyeduschool.