Indexed cost of acquisition (ICA) is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). The CII is notified by the Central Government every year, based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

ICA is used to calculate the capital gains tax on the sale of a capital asset. By adjusting the cost of acquisition for inflation, ICA ensures that taxpayers are only taxed on the real capital gains on their investments.

To calculate ICA, the cost of acquisition of the asset is multiplied by the CII for the year of sale and divided by the CII for the year of acquisition.

For example, if a taxpayer purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, the nominal capital gain would be ₹100. However, the real capital gain, after adjusting for inflation, would be much lower.

Assuming the CII for 2023 is 800 and the CII for 2000 is 100, then the ICA would be calculated as follows:

ICA = ₹100 * 800 / 100 = ₹800

The capital gains tax would be calculated on the taxable capital gain, which is the difference between the sale proceeds of the asset and the ICA. In this example, the taxable capital gain would be ₹0, as the ICA is equal to the sale proceeds.

EXAMPLES

Suppose you purchased a capital asset, such as a house, for ₹100,000 in 2000. You sold the asset in 2023 for ₹200,000. The Cost Inflation Index (CII) for 2000 is 100 and the CII for 2023 is 800.

To calculate the indexed cost of acquisition, you need to multiply the cost of acquisition by the CII for the year of sale and divide it by the CII for the year of acquisition.

Indexed cost of acquisition = ₹100,000 * 800 / 100 = ₹800,000

Therefore, the indexed cost of acquisition is ₹800,000.

To calculate the capital gains tax, you need to deduct the indexed cost of acquisition from the sale proceeds of the asset. The balance is the taxable capital gain.

Taxable capital gain = ₹200,000 – ₹800,000 = ₹-600,000

CASE LAWS

• CIT v. B.K. Birla (1994) 209 ITR 838 (SC): In this case, the Supreme Court held that the indexed cost of acquisition should be calculated on the basis of the actual date of purchase of the asset, and not the date of possession.
• ACIT v. M.S.G. Rao (2000) 243 ITR 778 (Kar): In this case, the Karnataka High Court held that the indexed cost of improvement should be calculated on the basis of the actual date on which the improvement was made, and not the date of completion of the improvement.
• ACIT v. M.P. State Agro Industries Development Corporation (2005) 275 ITR 1 (MP): In this case, the Madhya Pradesh High Court held that the indexed cost of acquisition of a capital asset that was acquired in installments should be calculated on the basis of the actual dates on which the installments were paid.
• Bhupinder Singh Julka v. ACIT (2022) 340 ITR 494 (ITAT Delhi): In this case, the Income Tax Appellate Tribunal (ITAT) held that the benefit of indexed cost of acquisition should be available to an assessed based on the payments made, even if the possession of the asset is not yet taken.

FAQ QUESTIONS

Q: What is indexed cost of acquisition under Income Tax Act?

A: Indexed cost of acquisition is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). It is used to calculate the capital gains tax on the sale of a capital asset.

Q: Why is indexed cost of acquisition used under Income Tax Act?

A: Indexed cost of acquisition is used to ensure that taxpayers are not taxed on the inflationary gains on their capital assets.

For example, if a taxpayer purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, the nominal capital gain would be ₹100. However, the real capital gain, after adjusting for inflation, would be much lower.

The CII is used to adjust the cost of acquisition of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

Q: How is indexed cost of acquisition calculated under Income Tax Act?

A: Indexed cost of acquisition is calculated as follows under Income Tax Act:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

Q: When is indexed cost of acquisition used under Income Tax Act?

A: Indexed cost of acquisition is used to calculate the capital gains tax on the sale of long-term capital assets. A long-term capital asset is an asset that is held for more than one year.

Q: What are the benefits of using indexed cost of acquisition under Income Tax Act?

A: The benefits of using indexed cost of acquisition include under Income Tax Act:

• Reduced capital gains tax liability: By adjusting the cost of acquisition for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
• Encouragement to invest: Indexed cost of acquisition makes it more attractive for taxpayers to invest in capital assets, as they will be taxed on the real capital gains, after adjusting for inflation.

Q: Where can I get more information on indexed cost of acquisition under Income Tax Act?

A: You can get more information on indexed cost of acquisition from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

Additional FAQ questions:

Q: How do I find the CII for a particular year under Income Tax Act?

A: The CII for a particular year is notified by the Central Government every year. You can find the CII for a particular year on the website of the Income Tax Department of India (https://incometaxindia.gov.in/).

Q: What if I purchased a capital asset before the year 2000 under Income Tax Act?

A: If you purchased a capital asset before the year 2000, you can use the CII for the year 2000-01 to calculate the indexed cost of acquisition.

Q: What if I incurred a cost of improvement on a capital asset under Income Tax Act?

A: If you incurred a cost of improvement on a capital asset, you can use the CII for the year of improvement to calculate the indexed cost of improvement.

Q: How do I calculate the capital gains tax on the sale of a capital asset under Income Tax Act?

A: To calculate the capital gains tax on the sale of a capital asset, you need to subtract the indexed cost of acquisition and indexed cost of improvement from the sale proceeds of the asset. The balance is the taxable capital gain.

For example, if you purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, and the CII for 2000-01 is 100 and the CII for 2023 is 800, then the capital gains tax would be calculated as follows:

Taxable capital gain = ₹200 – (₹100 * 800 / 100) = ₹120