The rising cost of inflation has its impact on every investor and there are different efforts to ensure that the effects of this are reduced. On the income tax front there is a direct relief on this front available in the form of the Cost Inflation Index (CII) that will increase the cost of the assets and investments and hence reduce the capital gains that will be taxable. Here is a look at the entire concept and how it works for the individual tax payer.

What is CII?

CII is a figure that is announced by the tax authorities each year that represents the impact of the inflation in the economy. This is a figure that will determine the extent of the benefit that the individual will receive on their investments when they sell them and a capital gains tax has to be paid on it. The manner in which this works is that the CII is used to increase the cost on the investment based on the year of purchase and the year of sale. This is then compared to the selling price to arrive at the final figure.

So for example if there is an asset that is bought in 2003-04 for a price of Rs 50,000 and it is sold in 2010-11 for a sum of Rs 1.2 lakh then the gain for tax purposes is not Rs 70,000 ( Rs 120,000 – RS 50,000) but is actually lower. The working will result in the cost of purchase being calculated as Rs 50,000 X 711 ( CII of year of sale)/463 (CII of year of purchase) = Rs 76,782. The capital gain in this case stands at Rs 43,218.

Applicability

The use of the CII is possible only for long term capital assets where there is a tax to be paid on the capital gains that arises from the transactions. This means that two categories will be out of the ambit of the use of the CII. The first is a situation  where there is a short term capital gains as in such a situation there is direct comparison of the sale price with the  cost price to arrive at the amount of gain that will be  taxable.

The second is a situation where there is a long term capital gains but this is tax free as in such a situation making the working with the CII calculations has no use as there is no tax to be paid. A couple of areas where this is widely used will be in case of real estate transactions like sale of a house property or the sale of a debt instruments like debt mutual funds. 

Effective use

The most effective use will be  visible in case of debt instruments like debt funds where the investor can  ensure  that a large part of their gains are actually tax free in their hands. One of the things that is witnessed is that the debt funds show a steady rise over a period of time and when this is kept for a period of more than a year then the CII will be applicable. In such a situation with the rise in the CII over the past couple of years being high and nearly more than 8-9 per cent this can result in a better situation on the tax front.

A large part of the gains that are recorded on the debt funds can actually turn out to be tax free for the investors when held for a period of one year and this will result in a situation where the net returns are significant. This is a benefit that needs to be used effectively. Another thing that also has to be kept in mind is that there will be a holding period of 3 years for the gains to be long term in case of house property but this will be just one year for debt investment like mutual funds