What is Cost Inflation Index(CII) and how can Cost Inflation Index help you to save tax in 2013-14?
Do you know that Inflation will help you in saving Tax? Confusing?
Yes, the government has given certain provisions in the Income Tax rules, which will help you in saving tax to offset the effect of inflation on your investments.
Cost Inflation Index – What is it?
This is an Index started in the FY 1981-82 with 100 as the base. The value for each year will be declared by the government considering the inflation in the country. The value for the FY 2013-14 is 939. This Index is useful in arriving at the indexed cost of a capital asset like property, mutual funds etc.
Cost Inflation Index Table from FY 1981-82 to 2013-14
Cost Inflation Index-Useful to save Tax?
Knowledge of Cost Inflation Index is necessary for computing Long-Term Capital Gains. The Capital Gains will be computed after deducting the indexed cost of acquisition from the sale value. The cost of purchase of the asset will be increased by applying the Cost Inflation Index (CII). Once the Cost Inflation Index is applied to the cost of acquisition, it becomes indexed cost of acquisition.
If you are selling a capital asset after 3 years of its purchase, the gains will be considered as Long-Term Capital Gains. Otherwise, the gain will be Short-Term Capital Gains. For Mutual Funds and ETFs, this period is 1 year. The tax rate of Long-Term Capital Gains is 20% with indexation benefits or 10% without indexation benefits. The tax rate for Short-Term Capital Gains is the same as your tax slab.
How to calculate Capital Gains with Cost Inflation Index?
Suppose, you have purchased a property in the FY 1999-2000 for Rs. 10 Lakhs and sold it in the FY 2011-12 for Rs. 25 Lakhs.
Cost Inflation Index for the FY 1999-2000: 389
Cost Inflation Index for the FY 2011-12: 785
Purchase Price: Rs. 10 Lakhs; Indexed Purchase Price = Rs. 10,00,000 x 785/389 = Rs. 20,17,995.
Sale Price: Rs. 25 Lakhs; Long-Term Capital Gains = Rs. 25,00,000 – Rs. 20,17,995 = Rs. 4,82,005.
Long-Term Capital Gains Tax @ 20% = 20% of Rs. 4,82,005 = Rs. 96,401.
Though the actual gain in the sale is Rs. 15 Lakhs (Rs. 25 lakhs – Rs. 10 Lakhs), the Long-Term Capital Gains for taxation after indexation benefit is only Rs. 4,82,005 and you have to pay tax for this amount only at the rate of 20%. This is how the Cost Inflation Index will help you in reducing the tax on Capital Gains. The value of this Index will be high during periods of high inflation.
Long-Term Capital Gains = Selling Price – Indexed Purchase Price
If you have spent any amount for repair (improvement) of the property after purchase, that cost also can be indexed and added to the indexed purchase price to arrive at the Capital Gains.
If the property is purchased before 1982, the same has to be valued from registered valuer and then indexed accordingly.
How to save Long-Term Capital Gains Tax?
If you are buying another house and invests the Capital Gains in that, you can avoid Capital Gains Tax under Section 54. You can either buy a new house within 2 years from the date of sale of the old one or you can construct a new house within 3 years. You can also buy a house 1 year prior to selling the old house.
If after selling the property, you are unable to identify a new property, then you have to deposit the Capital Gains amount in Capital Gain Account Scheme. All the withdrawal from this account should be made only for purchase of a new property. But, if you cannot invest the amount in 3 years, then the entire amount will be exposed to Long- Term Capital Gains Tax.
There is one more way to save Long-Term Capital Gains Tax. Under Section 54EC, you can invest the Capital Gains in specified bonds issued by Rural Electrification Corporation (REC) or National Highways Authority of India (NHAI). But there is an upper limit of Rs. 50 Lakhs in this. Such bonds now offer 6% returns and there is a lock-in period of 3 years.
Cost Inflation Index – Tax Saver
Cost Inflation Index will help you in saving tax and it will offset the effect of inflation. If you are selling a Debt Mutual Fund after 1 year, there also you can apply the Cost Inflation Index to increase the purchase cost and save tax.