Cost Inflation Index [Explanation (v) to Section 48 of the Income Tax Act, 1961]
The world’s economy is dynamic and subject to constant change. This change is evident from a decrease in the purchasing power of money due to a sustained rise in the prices of goods and services. The phenomenon of a reduction in the value of money, which leads to an increase of an individual’s cost of living, is known as inflation.
Cost of Inflation Index (CII) is basically price Inflation Adjustment due to the timing difference between date of Purchase of Asset and date of sale of Asset. It is present Purchase value of the asset that is to be sold.
Cost Inflation Index is a tool used in the calculation of an estimated yearly increase in an asset’s price as a result of inflation. The Central Government fixes this index and publishes it in its official gazette for measuring inflation. This index, notified each year by the Government is defined under Section 48 of the Income Tax Act, 1961.
The intention of the legislature is to tax the real gain on transfer of the capital asset not the profit due to inflation. In order to achieve this objective, the “Indexation” is introduced in capital gain taxation. The indexation benefit is meant to take into account the inflationary trends between the year of purchase and the year of sale. The costs incurred on the sale are allowed as deduction while calculating gains from the sale of both short-term and long-term assets.
Text of Explanation (v) to section 48
“COST INFLATION INDEX” in relation to a previous year, means such index as the Central Government may, having regard to 75% of average rise in the Consumer Price Index (urban) for the immediately preceding previous year to such previous year, by notification in the official Gazette, specify, in this behalf.”
Meaning of Base Year in Cost Inflation Index (CII)
The base year is the first year in the index whose value is set at 100. The indexation of years following base year is done in accordance with base year to check their increase in the inflation percentage.
For assets purchased before the base year of CII, assessees can consider their purchase price as the higher between their Fair Market Value (FMV) and actual cost of the same on 1st day of the base year. The benefit of indexation is then applied to the calculated purchase price of assets. On the other hand, FMV is calculated based on the asset’s valuation report as presented by a registered valuer.
Purpose of Cost Inflation Index (CII)
A Cost Inflation Index table is used to calculate the long term capital gains from a transfer or sale of capital assets. Capital gain refers to the profit acquired from the sale/transfer of any capital assets, including land, property, stocks, shares, trademarks, patents, etc.
In accounting, usually, long term capital assets are recorded at their cost price in books. Thus, despite rising prices of assets, these capital assets cannot be revalued. At the time of sale of these assets, the profit or gain acquired from them remains high due to their high sale price in comparison to their purchase price. As a result, assessees also have to pay a higher income tax on the gains from these assets. To tax the real gain on transfer of the capital asset not the profit due to inflation. In order to achieve this objective, the “Indexation” is introduced in capital gain taxation.
How to do indexation
Cost of acquisition is computed with the help of following formula:—
Cost of acquisition
(Fair Market Value on 01.04.2001 or
Cost of Acquisition, whichever is more) X Cost Inflation Index of year of transfer of capital asset
Cost Inflation Index of the year of acquisition (or Base Year i.e. 100)
|Mr. `X’ purchased a house for Rs. 1,50,000/- in 1998. The fair market value on 01.04.2001 was Rs. 7,00,000/-. He sold the house for Rs. 24,00,000 on 19.03.2020. Find out the Indexed cost of acquisition.|
|Cost of acquisition
(Fair Market Value on 01.04.2001 or
Cost of Acquisition,
whichever is more) X Cost Inflation Index of the year in which the asset is transferred
Cost Inflation Index of the year of acquisition (or Base Year i.e. 100)
|7,00,000 x 280 = Rs. 20,23,000
Central Government notifies the cost inflation index
Central Government specifies the cost inflation index by notifying in the official gazette.
Cost Inflation Index = 75% of the average rise in the Consumer Price Index* (urban) for the immediately preceding year
*Consumer Price Index compares the current price of a basket of goods and services (which represent the economy) with the price of the same basket of goods and services in the previous year to calculate the increase in prices.
Consumer Price Index (Urban) – Applicable from the assessment year 2016-17.
Indexation of cost to be allowed
(i) Indexation of cost will be allowed in case of capital indexed bonds
(ii) In case of long-term capital gains arising from the transfer of sovereign gold bond (Third proviso to section 48)
With effect from assessment year 2017-18, the following third proviso has been substituted by the Finance Act, 2016:—
“Provided also that nothing contained in the second proviso (relating to indexation of cost) shall apply to the long-term capital gain arising from the transfer of a long-term capital asset, being a bond or debenture other than—
(a) capital indexed bonds issued by the Government; or
(b) Sovereign Gold Bond issued by the Reserve Bank of India under the Sovereign Gold Bond Scheme, 2015.”
Thus, besides capital indexed bonds, indexation benefits to long-term capital gains arising on transfer of Sovereign Gold Bond shall be allowed to all classes of assessees.
Cases where benefit of indexation is not available in the case of long-term capital assets
In the following cases, the benefit of indexation is not available even if such asset is a long-term capital asset:—
|S. No.||Nature of long-term capital asset transferred||Assessee (Transferor) not eligible for indexation benefit|
|(i)||Short-term capital assets
v In case of depreciable assets, there is no question of any indexation as capital gain arising from the transfer of depreciable asset shall always be short-term capital gain.
|(ii)||BONDS AND DEBENTURES
Transfer of Bonds or Debentures of any company whether public or private or Government company or bonds of Government [however, benefit is available to capital indexed bonds issued by Government] except the following:
|(a) Capital indexed Bonds issued by the Government; or|
|(b) Sovereign Gold Bond issued by the Reserve Bank of India under the Sovereign Gold Bond Scheme, 2015 [(Clause (b) inserted by the Finance Act, 2016, with effect from assessment year 2017-18)] – (Proviso to section 48)|
|(iii)||SLUMP SALE UNDER SECTION 50B Undertaking or division transferred by way of slump sale as covered by section 50B||All Assessees|
|(iv)||SALE OF SHARES BY NON-RESIDENT
Transfer of Shares or Debentures acquired by a non-resident in foreign currency in an Indian company (by utilizing convertible foreign exchange) (Provisos 1 and 2 to Section 48)
Other than an asset used by a power generating unit eligible for depreciation on straight line basis.
In case of depreciable assets for which All Assessees block of assets system is followed, there is no question of any indexation a capital gain arising from the transfer of depreciable asset shall always be short-term capital gain
|(vi)||Transfer of Units of Unit Trust of India or Mutual Fund covered under section 10(23D) purchased in Foreign Currency by overseas financial organization also known as offshore funds (section 115AB)||Off Shore Fund|
|(vii)||Receipts (GDR) or bonds of an Indian company or share or bonds of public sector company sold by the Government and purchased in foreign currency by a non-resident (section 115AC)||Non-Residents|
|(viii)||Global Depository Receipts (GDR) purchased in foreign currencies by an individual resident in India and employee of an Indian company (section 115ACA)||Resident individual|
|(ix)||Transfer of Securities held by Foreign Institutional Investors (section 115AD)||Foreign Institutional Investors (FII)|
|(x)||Transfer of Foreign Exchange Asset held by a Non-Resident Indian (NRI) (section 115D)||Non-Resident Indian(NRI)|
|(xi)||Transfer of unlisted securities by non-resident [Clause (c) of proviso to section 112(1)]||Non-Resident (not being a company) or a foreign company|
In the above cases, the provisions relating to indexed cost of acquisition and indexed cost of improvement are not applicable.
Q 8. Whether the cost of acquisition will be inflation indexed?
Answer 8. Sub-clause (5) of clause 31 of the Finance Bill, 2018, inter alia, provides that the long-term capital gain will be computed without giving effect to the provisions of the second provisos of section 48. Accordingly, it is clarified that the benefit of inflation indexation of the cost of acquisition would not be available for computing long-term capital gains under the new tax regime. [CBDT’s FAQs dated 04.02.2018 regarding taxation of long-term capital gains (LTCG) on stocks proposed in Finance Bill, 2018]
Sale of inherited property – cost inflation index has to be applied with reference to year in which said capital asset was first acquired by previous owner [Section 55(2)(b)(ii)]
Dismissing the appeal of the revenue , the Tribunal held that ; where assessee sells an inherited property, for computing amount of capital gain, cost inflation index has to be applied with reference to year in which said capital asset was first acquired by previous owner. (Related Assessment year : 2007-08) – [ITO v. Sudip Roy (2016) 161 ITD 709 (ITAT Kolata)]
Cost of acquisition- Indexation – Capital asset inherited – originally acquired prior to 01.04.1981 – base cost inflation index to be taken of Financial Year 1981-82 i.e 100. Assessee inherited property in A.Y. 07-08. This property was acquired in the year 1979. Held cost inflation index base year to be taken as 1981. Followed Bombay High Court in CIT v. Manjula J. Shah (355 ITR 474) (Related Assessment year : 2007-08) – [CIT v. Nita Kamlesh Tanna (Smt.) (2014) 220 Taxmann 165 (Mag.)(Bom)]
The facts of the case are that the assessee acquired a residential flat as a gift from her daughter under a gift deed dated 02.01.2003. The said flat was originally acquired by the previous owner on 29.01.1993. The assessee sold the flat on 30.06.2003 and offered long-term capital gains. While calculating the capital gains, she took the index of year 1993-94. The ITO recomputed the capital gains with index of 2002-03 and passed order accordingly. The appeal before CIT (Appeals) and the ITAT was decided in favour of the assessee. The revenue preferred appeal before the Bombay High Court which was again decided in favour of the assessee. While delivering the order, the Bombay High Court, laid down that when the law provides to consider the period of holding of the previous owner also, then a different treatment cannot be accorded for calculation of the indexed cost of acquisition by not adopting the cost inflation index of the year in which the asset was acquired by the previous owner. Therefore, the court said, indexation should be allowed from the year in which such asset was acquired by the previous owner.—[CIT v. Manjula J. Shah (2011) 16 Taxmann.com 42]
Indexed cost of acquisition of house inherited from father – Sale of house inherited from father – Cost of acquisition of house to the assessee has to be deemed to be the cost for which the previous owner had acquired it
The facts of the case are that the assessee and her sister were owners of one residential Kothi in Chandigarh and the same was sold by them in the accounting year 1992-93. The said house was inherited by the above mentioned ladies from their father, who died on 17.02.1991. Their father had built the house long back, i.e., much earlier to 01.04.1981 and had bequeathed the same to his daughters. Capital gain is worked out by applying the cost inflation index (denominator) of financial year 1981-82. The ITO and the CIT (Appeals) did not agree with this, since their view was that the indexed cost of acquisition was to be worked out with reference to the date on which the father of the assessee expired i.e. on 17.02.1991 by applying Explanation (iii) to section 48. The assessee preferred second appeal before the ITAT which decided the case in favour of the assessees. The Tribunal observed that as the asset was acquired prior to 1981, the indexed cost of acquisition in the hands of the previous owner as on 01.04.1981 (100) was to be considered for computing the capital gains.— [Mrs. Pushpa Sofat v. ITO (2004) 89 TTJ 499 (2002) 81 ITD 1 (ITAT Chandigarh)]
Cost of acquisition – Property inherited indexed cost to be determined as on 01.04.1981
The assessee has declared long-term capital gain, claiming the indexation cost as on 1st April, 1981. The Assessing Officer held that the father of the assessee had expired on 6th April, 1990 hence indexation will be available only with the reference to financial year 1990-91. In appeal, the Commissioner (Appeals) allowed the claim of indexation from 01.04.1981. On appeal by revenue, the Tribunal held that as the property was acquired by assessee’s father in 1965 and inherited by assessee on death of his father in 1990, indexed cost of acquisition of property shall have to be determined as on 1st April, 1981, for purpose of computation of capital gains. (Related Assessment year : 2007-08) – [ACIT v. Suresh Verma (2012) 135 ITD 102 : 72 DTR 82 (ITAT Delhi)]
Gifted property : Indexation
In case of transfer by gift, will, trust, etc. indexed cost to be determined with reference to holding by previous owner
In case of transfer by gift, will, trust, etc indexed cost to be determined with reference to holding by previous owner – To be computed with reference to the year in which the previous owner first held the property
The settlor acquired property before 01.04.1981 and he settled in on trust on 05.01.1996. The assessee-trust sold the property and computed the indexed cost of acquisition on the basis that it “held” the property from the time the settlor had held it. The Assessing Officer accepted that the settlor’s cost of acquisition had to be treated as the assessee’s cost of acquisition but held that the settlor’s period of holding could not be treated as the assessee’s period of holding. This was upheld by the Tribunal. On appeal by the assessee to the High Court, HELD reversing the Tribunal:
The department’s contention that in a case where section 49 applies the holding of the predecessor has to be accounted for the purpose of computing the cost of acquisition, cost of improvement and indexed cost of improvement but not for the indexed cost of acquisition will result in absurdities. It leads to a disconnect and contradiction between “indexed cost of acquisition” and “indexed cost of improvement”. This cannot be the intention behind the enactment of section 49 and the Explanation to section 48. There is no reason why the legislature would want to deny or deprive an assessee the benefit of the previous holding for computing “indexed cost of acquisition” while allowing the said benefit for computing “indexed cost of improvement”. The benefit of indexed cost of inflation is given to ensure that the taxpayer pays capital gain tax on the “real” or actual “gain” and not on the increase in the capital value of the property due to inflation. The expression “held by the assessee” used in Explanation (iii) to section 48 has to be understood in the context and harmoniously with other Sections and as the cost of acquisition stipulated in section 49 means the cost for which the previous owner had acquired the property, the term “held by the assessee” should be interpreted to include the period during which the property was held by the previous owner (CIT v. Manjula J. Shah 16 Taxman 42 (Bom) followed). (Related Assessment year : 2001-02) – [Arun Shungloo Trust v. CIT – Date of Judgement : 13.02.2012 (Del.) ]
Family arrangement is analogous to partition attracting Section 49 [Family arrangement (Settlement)]
In case of property acquired by way of family settlement dated 01.09.1997, effective from 31.07.1992, for purposes of computing capital gains, deduction has to be allowed on indexed cost of acquisition by taking into account its fair market value as on 01.04.1981 [The property was acquired by the previous owner in 1966] – [ACIT v. Baldev Raj Charla (2009) 121 TTJ 366 : 18 DTR 413 (Del)]
Cost Inflation Index
Applicable from Assessment Year 2018-19 [with Base Year 2001-02]
|S. No.||Financial year||Cost Inflation Index|
Applicable up to Assessment Year 2017-18 [with Base Year 1981-82]
|S. No.||Financial year||Cost Inflation Index|