COST INFLATION INDEX

Cost Inflation Index is a measure of inflation that is used for computing long-term capital gains on sale of capital assets. It is prescribed by the central government every year and useful in the calculation of the indexed value of the capital assets. It helps a tax payer in computing the actual long-term gain or loss on selling of capital assets and also allows the tax payer to factor the impact of inflation on the cost of their asset. To calculate the indexed cost of acquisition we have to divide the Cost Inflation Index or CII for year in which asset is sold by the Cost Inflation Index or CII for a year in which asset is bought, then multiplied with the purchase price of the asset to arrive at the indexed cost of acquisition which is the actual or true cost used at the time of tax computation. Since the government levies a tax on such transactions, the owner would be required to pay a large amount as tax. In order to avoid paying a large sum towards tax, the purchase price of the asset can be indexed to show the asset’s value as per its current value, taking into account inflation by increasing its value. In this manner, the profit derived from the sale would be lower, thus reducing the tax on capital gains.
Thus, indexation helps the actual value of the asset to reflect at its present market rates, taking into account the reduction in its value due to inflation. When selling an asset, the purchase price is referred to as the indexed cost of acquisition. The cost inflation index (CII), therefore, is the indexed price that the asset is purchased at. The CII for a particular year is fixed by the government and released before the accounting year ends, for the purpose of tax computation.