Indexed cost of improvement is the cost of improvement 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.

The CII is a measure of inflation that is published by the Central Government of India every year. It is calculated based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

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

For example, if you incurred a cost of improvement of ₹50 on a capital asset in 2005 and sold it for ₹200 in 2023, and the CII for 2005 is 200 and the CII for 2023 is 800, then the indexed cost of improvement would be calculated as follows:

Indexed cost of improvement = ₹50 * 800 / 200 = ₹200

The indexed cost of improvement is deducted from the sale proceeds of the capital asset to calculate the taxable capital gain. The capital gains tax on the taxable capital gain would depend on the taxpayer’s income tax slab.

Indexed cost of improvement is an important concept in the Income Tax Act of India, as it helps to reduce the capital gains tax liability of taxpayers. By adjusting the cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.

EXAMPLE

Example of Indexed Cost of Improvement

Let’s say a taxpayer purchased a property for ₹10,000,000 in 2000 and incurred a cost of improvement of ₹5,000,000 in 2005. The property was sold in 2023 for ₹20,000,000.

To calculate the indexed cost of improvement, we need to use the Cost Inflation Index (CII) for the year of improvement and the year of sale.

The CII for 2005 is 200 and the CII for 2023 is 800.

Indexed cost of improvement = ₹5,000,000 * 800 / 200 = ₹20,000,000

To calculate the capital gains tax, we need to subtract the indexed cost of acquisition and indexed cost of improvement from the sale proceeds of the asset.

Taxable capital gain = ₹20,000,000 – (₹10,000,000 * 800 / 100 + ₹20,000,000) = ₹30,000,000

The capital gains tax on the taxable capital gain of ₹30,000,000 would depend on the taxpayer’s income tax slab

CASE LAWS

CASE LAWS OF INDEXED COST OF IMPROVEMENT

Scenario:

A taxpayer, Mr. A, purchased a land for ₹100,000 in 2000. In 2005, he incurred a cost of improvement of ₹50,000 on the land. He sold the land in 2023 for ₹200,000.

Calculation of indexed cost of improvement under Income Tax Act:

Indexed cost of improvement = ₹50,000 * CII for 2023 / CII for 2005

Assuming the CII for 2023 is 800 and the CII for 2005 is 200, then the indexed cost of improvement would be ₹200,000.

Calculation of capital gains tax:

Taxable capital gain = ₹200,000 – (₹100,000 + ₹200,000) = ₹0

Since the taxable capital gain is ₹0, Mr. A would not have to pay any capital gains tax on the sale of the land.

However, it is important to note that the above calculation is just an example. The actual capital gains tax liability of the taxpayer would depend on a number of factors, such as their income tax slab and whether they are eligible for any exemptions or deductions.

Additional Information:

• The indexed cost of improvement is calculated in the same way as the indexed cost of acquisition.
• The indexed cost of improvement is used to reduce the taxable capital gain on the sale of a capital asset.
• The indexed cost of improvement is especially beneficial for taxpayers who have incurred significant costs of improvement on their capital assets over a period of time.

FAQ QUESTION

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

A: Indexed cost of improvement is the cost of improvement 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 improvement used under Income Tax Act?

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

For example, if a taxpayer incurred a cost of improvement of ₹50 on a capital asset in 2005 and sold it for ₹200 in 2023, the nominal capital gain would be ₹150. However, the real capital gain, after adjusting for inflation, would be much lower.

The CII is used to adjust the 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 indexed cost of improvement calculated under Income Tax Act?

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

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

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

A: Indexed cost of improvement 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 improvement under Income Tax Act?

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

• Reduced capital gains tax liability: By adjusting the cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
• Encouragement to invest: Indexed cost of improvement 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 improvement under Income Tax Act?

A: You can get more information on indexed cost of improvement 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 incurred a cost of improvement on a capital asset before the year 2000?

A: If you incurred a cost of improvement on a capital asset before the year 2000, you can use the CII for the year 2000-01 to calculate the indexed cost of improvement