What does this mean?
Cost Inflation Index (CII), although it might sound a complex term but it is not so difficult to comprehend. It simply means a concept through which cost can be indexed in order to adjust for inflation (as it increases every year).
Let’s understand this with the help of example
In year 2010, I purchased a House worth Rs 20,00,000 (20 Lakhs) an Later in year 2014, I sold it for Rs 30,00,000 (30 Lakhs).
Here I made a profit or Rs 10,00,000 (10 Lakhs).
Question : Do I have to pay the Tax for this profit income of 10 Lakhs?
Answer : Since I sold it after 3 years it is considered as Long term Capital Gain, I do not have to pay for 10 Lakhs, only for the actual profit of Rs. 1.20 Lakhs (after deducting inflation indexed value - Method of calculation given below)
For long-term capital gain, I can get the advantage of indexation. By using Indexation for calculating Tax, inflation is also taken into consideration. So the final amount which I have to pay as tax will be much lesser than this.
Since, due to inflation, price has increased as this profit also consists of inflation.
So, in order to compute actual cost (free from inflation), cost inflation index is used.
How to Calculate Tax using Cost Inflation Index?
Using the above example, Let us calculate the potential Tax for the profit income.
CII in year 2010 : 711 (as published by Income Tax Department)
CII in year 2014 : 1024 (as published by Income Tax Department)
Variation in CII
= CII of Selling Year / CII of Buying Year
= 1024 / 711 = 1.44
Buying Price of House = Rs. 20,00,000 (20 Lakhs)
Selling Price of House = Rs. 30,00,000 (30 Lakhs)
Indexed Price of House
= Buying Price of House x Variation in CII
= Rs. 20,00,000 x 1.44 = 28,80,000
Long Term Capital Gain
= Selling Price of House - Indexed Price of House
= 30,00,000 (30 Lakhs) - 28,80,000 (28 Lakhs+)
= Rs. 1,20,000 (Rs. 1.20 Lakhs)
So instead of Paying tax for profit of Rs. 10 Lakhs after holding the property for about 4 years, I have to pay tax for only Rs. 1.2 Lakhs.
Depending on the Tax slab it can be 10% / 20% / 30% of Rs. 1.20 lakhs
( If it is 20%, then I have to pay Rs 24,000 as Capital Gain Tax)
Features
The base year for computing Cost Inflation Index is year 1981 having value 100.
Every year, Income Tax Department publishes the CII. For Financial year 2015-16, it is 1081. This is prepared by Central Board of Direct taxes and is used in calculating long term capital gains for filing income tax return.
It is basically used to index the cost of acquisition and cost of improvement of an asset. Since, cost of acquisition is historical and CII concept will index it so, a taxpayer has to pay tax on lower profits instead of higher profits.
