Cost of Inflation Index upto FY 2013-14. (The year mentioned is financial year(FY)
The cost of inflation index is useful for income-tax assesses in the computation of tax on long-term capital gains (for indexation purposes). In the previous two years, the cost inflation index rose 10 per cent and 12.5 per cent, respectively.
A cost inflation index helps reduce the inflationary gains, thereby reducing the long-term capital gains tax payout for the taxpayer. Currently, the income-tax law allows long-term capital gains to be computed after adjusting for inflation (Debt Mutual Funds, FMP’s, Real Estate Gains etc.) .
The cost of acquisition as well as the cost of improvement is adjusted for inflation between the date of purchase and date of sale (through the cost inflation index) before the long-term capital gain is ascertained.
Assume, if the investor invested Rs 1,00,000 in the growth option on March 30, 2012 and redeemed the investment on April 2, 2013 for Rs 1,10,000
The investment happened in financial year 2011-12, for which the government has declared cost inflation index of 785.
The investor redeemed the investment in financial year in 2013-14, for which the cost inflation index is 939.
The capital gains is Rs. 110,000 minus Rs. 100,000 i.e. Rs. 10,000.
The holding period is 367 days, which is more than 1 year. Therefore, it is a long term capital gain.
The maximum tax the investor has to bear is 10% (plus surcharge plus education cess) on the capital gain of Rs. 10,000. Thus, the maximum tax payable would be Rs. 1,000 (plus surcharge plus education cess).
Investor can benefit from indexation. The indexed cost of acquisition is Rs. 100,000 X 939 ÷ 785 i.e. Rs. 119,618 . This is higher than the selling price of Rs. 110,000. Thus, the investor ends up with a long term capital loss of Rs. 9,618. So no tax payable and also this can be set off against long term capital gains, as discussed in the next section.
Another point to note is that although the investor held the investment for slightly more than a year, the investor gets the benefit of indexation for two years viz. 2011-12 and 2012-13. Hence the name “double indexation” for such structures.
Mutual funds tend to come out with fixed maturity plans (FMP’s) towards the end of every financial year to help them benefit from such double indexation. Even short term debt is a good investment towards the financial year end, as they too offer the same benefits.
Largely investors are unaware about this benefit. This benefit can and should be taken by investors who are in 30% tax bracket as they get the maximum benefit. So, invest in wither FMP’s or Short term Debt (Holding period > 1 yr) towards the end of a financial year, and sell towards the beginning of a financial year and take advantage of double indexation tax benefit for virtually tax free capital gains. Money saved is indeed Money earned.
Be Money Savvy and invest smart. Happy Investing.