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Indexation is a technique to arrive at profit/loss on investment by considering the effect of inflation which accounts for a rise in prices, cost of goods and services, and a decrease in currency value or purchasing power of money.
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Indexation in income tax is a process that takes into account the effect of inflation by adjusting the purchase price of an investment using a price index known as the 'Cost of Inflation Index (CII)'.
Resident Indians and NRIs are eligible to avail indexation benefit when investing for long term debt mutual funds. It makes debt funds an excellent investment option when compared to other fixed-income investments like Bank Fixed Deposits.
The Central Board of Direct Taxes notifies CII every year and is available on the income tax website.
Formula to calculate Indexed price:
Indexed Price = Original Purchase Price * (CII of Year of Sale/ CII of Year of Purchase)
Example
If Mr. A had purchased 10,000 units of Debt mutual fund at Rs 20 in the Financial Year 2014-15 and then sold these at Rs 32 in the Financial Year 2018-19, let us see the long-term capital gains with indexation and without indexation benefit.
Since the mutual funds were held for more than 3 years, the above transaction would attract long term capital gains (LTCG).
(Selling Price - Purchase Price) * No. of Units = (32- 20)* 10,000 = Rs 120,000
For that we will have to calculate the Indexed cost of acquisition. As per the above formula, the inflation-adjusted purchase price would be: 20 *(280/240) = Rs 23.40
[Note: CII for 2018-19 is 280 and that for 2014-15 is 240 as taken from Income Tax website]
Thus, LTCG considering inflation-adjusted price would be: 10,000 x (INR 32- INR 23.40) = INR 86,000
From the above example we can see that after considering the LTCG get reduced thereby leading to lesser tax liability.
Indexation is a great way to save taxes on long term debt mutual funds. Following are the key benefits of indexation:
Similar to resident Indians, NRIs are also eligible for Indexation benefits.
Indexation Income Tax benefits are available on capital gains realized in Debt mutual funds holding for 3 years or more. The benefits are not available on the capital gain from long term stocks holding, other types of mutual funds or bank fixed deposits.
Answered on
Indexation is a process to calculate the adjusted price of an asset using a price index which takes into account inflation over a period the asset was held.
In India, the Indexation Income Tax benefits are available on capital gains in Debt mutual funds when you hold them for at least 3 years. The Indexation offers better post-tax returns by reducing the tax liability.
Yes, NRIs can avail indexation benefit on long term debt mutual funds. Note that the indexation income tax benefits are not available on other investments like Property, Stocks, Equity Mutual Funds and Bank FDs.
Indexation benefit is restricted to long term debt mutual funds. They are not available on other investments like Property, Stocks, Other Mutual Funds, and Bank Fixed Deposits.
Indexation is done to consider the effect of inflation which impacts the purchasing power, price of goods and services, and rupee value. Indexation helps compare and justify the original price (when it was bought) of an asset with the current price in line with inflation.
Indexation is calculated using an index price called the Cost of Inflation Index (CII).
Mathematical Formula to calculate indexed price = Original Price of asset * (CII of Year of Sale/CII of Year of Purchase)
Cost of Inflation Index (CII) is a measure of inflation used to calculate the long term capital gains on the sale of an asset.
The Central Board of Direct Taxes (CBDT) (Central government) fixes and notifies the CII in its official gazette.
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