The previous post on capital gains mentions two ways of taxation for various asset classes- 10 % without indexation, and 20 % with indexation. What exactly is indexation, why is it required, and how to arrive at the indexed value? Let us find out –

What is indexation and why is it applied?

We all know that inflation reduces one’s purchasing power and reduces the value of the asset with passage of time. Hence, while calculating the profit earned by selling an asset bought a few years ago, the initial purchase price of the asset has to be multiplied by a factor called the Cost Inflation Index or CII to arrive at the inflation adjusted or the indexed cost of the asset. This helps us get the real value of the net capital gains.

How do we get to know the CII for the year of purchase?

The CII is published by the central government every year. The latest published value for the financial year 2012-2013 is 852. Here is a table with the historical values from 1982.

How to apply these CII values?

If an asset is bought for Rs. 100 in 2004 and was sold in 2012 for Rs. 1000, the indexed cost of purchase will be calculated as –

Actual cost incurred in 2004 * (CII index for 2012/CII index for 2004)

100 * (852/480) = 100 * 1.78 = 178.

Hence, the indexed cost of the asset for calculating the profit would be Rs. 178.

What happens if an asset is purchased before 1981?

Since the CII figures are published only from the year 1981 onwards, in case an asset is bought before 1 April 1981, its fair market value as on 1 April 1981 will be considered as cost of acquisition for indexation purposes.