Indexed cost of acquisition and indexed cost of improvement are two important concepts under the Income Tax Act of India. They are used to calculate the capital gains tax payable on the sale of capital assets.

Indexed cost of acquisition is the original cost of acquisition of a capital asset, adjusted for inflation. It is calculated by multiplying the original cost of acquisition by the cost inflation index (CII) for the year of sale and dividing it by the CII for the year of acquisition.

Indexed cost of improvement is the total cost of improvements made to a capital asset, adjusted for inflation. It is calculated by multiplying the total cost of improvements by the CII for the year of sale and dividing it by the CII for the year of improvement.

The indexed cost of acquisition and indexed cost of improvement are used to calculate the net capital gain, which is the difference between the sale price of the capital asset and the indexed cost of acquisition and indexed cost of improvement. The net capital gain is then taxed at the applicable capital gains tax rate.

Suppose an individual purchased a house for INR 10,000,000 in 2010 and sold it for INR 20,000,000 in 2023. The CII for 2010 is 100 and the CII for 2023 is 200.

The indexed cost of acquisition of the house would be:

Indexed cost of acquisition = INR 10,000,000 * 200 / 100 = INR 20,000,000

The net capital gain would be:

Net capital gain = INR 20,000,000 – INR 20,000,000 = INR 0

In this Case, the individual would not have to pay any capital gains tax on the sale of the house.

Benefits of using indexed cost of acquisition and indexed cost of improvement under Income Tax Act:

• Using indexed cost of acquisition and indexed cost of improvement helps to reduce the taxable capital gain, as the cost of acquisition and improvement is adjusted for inflation.
• This is beneficial for taxpayers, as they have to pay less capital gains tax.
• It also encourages investment and economic growth, as taxpayers are more likely to invest in capital assets if they know that they will not have to pay a high capital gains tax when they sell the asset.

CASE LAWS

• CIT Vs. Shri Harishchandra Agarwal (2001) 244 ITR 774 (SC): In this case, the Supreme Court held that the indexed cost of improvement is to be calculated using the Cost Inflation Index (CII) for the year in which the improvement was made, and not the CII for the year in which the asset was acquired.
• ITO Vs. Shri B.K. Modi (2016) 387 ITR 429 (CA): In this case, the Calcutta High Court held that the indexed cost of improvement is not limited to the cost of improvement that has been capitalized. The court also held that the indexed cost of improvement can be claimed even if the improvement was made prior to the introduction of indexation in 2001.
• CIT Vs. Shri Avinash B. Jain (2010) 325 ITR 561 (Trib): In this case, the Income Tax Tribunal held that the indexed cost of improvement is to be calculated using the CII for the year in which the improvement was made, even if the improvement was made prior to the introduction of indexation in 2001. The tribunal also held that the indexed cost of improvement can be claimed even if the improvement was not capitalized.

FAQ QUESTIONS

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

A: Indexed cost of acquisition and indexed cost of improvement are concepts used in the Income Tax Act of India to calculate the capital gains tax on the sale of capital assets.

Indexed cost of acquisition is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). Indexed cost of improvement is the cost of improvement of a capital asset, adjusted for inflation using the CII.

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

A: Indexed cost of acquisition and indexed cost of improvement are 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 indexed cost of acquisition and indexed cost of improvement calculated under Income Tax Act?

A: 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: When is indexed cost of acquisition and indexed cost of improvement used under Income Tax Act?

A: Indexed cost of acquisition and indexed cost of improvement are 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.

To calculate the capital gains tax on the sale of a long-term 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.

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

A: The benefits of using indexed cost of acquisition and indexed cost of improvement 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: Indexed cost of acquisition and indexed cost of improvement make 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 and indexed cost of improvement under Income Tax Act?

A: You can get more information on indexed cost of acquisition and 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.