What is Cost Inflation Index?

Cost inflation index, often abbreviated as CII, is a tool used to calculate an annual increase in an asset’s price resulting from inflation. Thus, to understand the concept of CII one must understand inflation. Inflation is the sustained rise of the general price level in an economy that reads as a reduction in the purchasing power of money.

What is cost inflation index in numerical terms? For instance, ‘A’ purchases 100 g of gold today priced at Rs 60,000. ‘A’ sells this gold after 4 years at Rs 70,000. Thus, he has gained Rs 10,000 off this sale. This is where inflation comes into the picture. Inflation in these 4 years may have reduced the value of money. Thus, selling the gold at a higher price is necessary to make up for the rise in price caused by inflation.

Cost inflation index is fixed by the Government and the index is published in the official gazette. The Central Board of Direct Taxes (CBDT) notifies the cost inflation index every year in the gazette. The CBDT estimates a three-digit number of cost inflation index for investors.

Why is Cost Inflation Index of any importance?

A cost inflation index chart helps determine the long-term capital gains from the sale of assets, i.e., it estimates the profit that may be gained from the sale of capital assets, such as stocks, shares, patents, land, etc.

Long-term capital assets are recorded at their cost price in the books of accounts. Thus, they don’t account for the market conditions. These capital asset records are not revalued. At the time of sale of these assets they are priced high, so that the gains cover the fall in money’s value from the time of purchase to sale. Cost inflation index helps adjust these values for the capital gain and sets the sale value in accordance with the purchase cost.

Cost inflation index calculator

What is the base year in CII?

The base year is used to calculate the cost inflation index, it is the first year in the index, the value of which is set at 100. The indexation of the succeeding years is set according to this base year. This helps check the increase in inflation percentage.

In case the capital asset was purchased before the base year of cost inflation index, one can take the higher of -- actual cost OR Fair Market Value (FMV) as on day 1 of the base year – as the purchase price of the assest. This actual cost (purchase price) is based on the valuation report of a registered valuer.

The base year was 1981-82 initially but now it is set at 2001. This was done to facilitate quicker and more accurate calculation for the tax authorities and taxpayers alike.

Understanding cost inflation index through an example,

‘A’ purchased gold for Rs 60,000 in 2001-02. Later, in 2017 he sells the gold. The cost inflation index for 2001-02 and 2017-18 was reported to be 100 and 272 respectively. What will be the indexed cost of acquisition?

The indexed cost of acquisition = 60,000 x 272/100 = Rs 1,63,200

Cost inflation index and Income Tax

The cost price of long-term capital assets is reflected in the books. They remain at their cost price and cannot be revalued despite rising inflation. However, since the sale price is higher than the acquisition price, when these assets are sold, the profit amount remains large. A greater income tax is the result of this phenomenon.

Long-term capital assets are subject to the cost inflation index, which results in higher acquisition costs and lower profits and taxes for the benefit of taxpayers. The cost inflation index benefit is applied to long-term capital assets for the benefit of taxpayers, resulting in higher purchase costs, lower profits, and lower taxes.

Conclusion

Cost inflation index may seem complicated at first. However, there are cost inflation index calculators that help make this easy for beginners. Understanding cost inflation index is essential if you want your tax liabilities to be reduced.