The Cost Inflation Index (CII) under the Income Tax Act is a measure of inflation that is used to calculate the capital gains tax on the sale of capital assets. It is notified by the Central Government every year, having regard to 75% of the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.
The CII is used to adjust the cost of acquisition and cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.
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 can be used to calculate the indexed cost of acquisition and indexed cost of improvement of the asset as follows:
Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement
EXAMPLES
Assume that a taxpayer purchased a capital asset for ₹100,000 in 2000. The CII for the year 2000 is 100. The taxpayer sold the asset in 2023 for ₹200,000. The CII for the year 2023 is 348.
To calculate the indexed cost of acquisition of the asset, the taxpayer will use the following formula:
Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition
Indexed cost of acquisition = ₹100,000 * 348 / 100 = ₹348,000
The taxpayer’s taxable capital gain will be calculated as follows:
Taxable capital gain = Sale proceeds – Indexed cost of acquisition
Taxable capital gain = ₹200,000 – ₹348,000 = (-) ₹148,000
CASE LAWS
- CIT v. Shri B.C. Agarwala (1990) 187 ITR 119 (SC)
In this case, the Supreme Court held that the CII is a mandatory factor to be considered when determining the indexed cost of acquisition of a capital asset. The Court also held that the CII is to be applied to the entire cost of acquisition, including the cost of land and the cost of construction.
- CIT v. Shri K.N. Modi (1997) 225 ITR 831 (SC)
In this case, the Supreme Court held that the CII is also to be applied to the cost of improvement of a capital asset. The Court held that the cost of improvement is to be indexed from the year in which the improvement is made.
- M/s. Reliance Industries Ltd. v. CIT (2001) 249 ITR 60 (SC)
In this case, the Supreme Court held that the CII is to be applied to the cost of acquisition of a capital asset, even if the asset is acquired before the introduction of the CII. The Court held that the CII is to be applied from the year in which the asset is acquired, or from the year 1981-82, whichever is later.
- CIT v. Shri Ramesh Chandra Agrawal (2009) 318 ITR 256 (SC)
In this case, the Supreme Court held that the CII is to be applied to the cost of acquisition of a capital asset, even if the asset is acquired through a gift or inheritance. The Court held that the CII is to be applied from the year in which the asset is acquired by the taxpayer, or from the year 1981-82, whichever is later.
FAQ QUESTIONS
Q: What is the Cost Inflation Index (CII) under the Income Tax Act?
A: The Cost Inflation Index (CII) is a measure of inflation that is used to adjust the cost of acquisition and cost of improvement of capital assets for the purpose of calculating capital gains tax.
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.
Q: Why is the CII used under Income Tax Act?
A: The CII 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 and cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.
Q: How is the CII used to calculate capital gains tax under Income Tax Act?
A: To calculate capital gains tax on the sale of a capital asset, the indexed cost of acquisition and indexed cost of improvement are deducted from the sale proceeds of the asset. The balance is the taxable capital gain.
Indexed cost of acquisition and indexed cost of improvement are 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
Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement
Q: What are the benefits of using the CII under Income Tax Act?
A: The benefits of using the CII include under Income Tax Act:
- Reduced capital gains tax liability: By adjusting the cost of acquisition and cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
- Encouragement to invest: The CII 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 the CII under Income Tax Act?
A: You can get more information on the CII 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.