Principle of Indexation

Whenever one sells any asset like Property, Jewelery, Bonds or Shares and makes a Profit, one has to pay tax known as Capital Gains. This is the tax on difference between Purchase and Sale price of the assets. Suppose you buy property worth Rs. 10 Lakhs and Sell for Rs. 25 Lakhs the Capital gains would be Rs. 15 Lakhs and you have to pay tax on these capital gains. But Govt. realizes the impact of inflation and gives the benefit of indexation if you have held the asset for more than 3 years i. e. you qualify for exemption as it is a Long Term Capital Gains. (For shares and equity mutual funds this holding period is one year, for debt mutual funds it is 3 years)

The Govt. comes out with a cost inflation index every year and one can avail the benefit of this while selling an asset.

 

Inflation indexed Cost =

Index of Sale year of asset X purchase price of asset

Index of Purchasing year of the asset

 

We will explain this concept in case of debt mutual funds (remember capital gains on equity mutual funds are tax free after one year)

Suppose you buy debt funds worth Rs. 1 Lakh in 2012 which earn 9% P.A. return for 3 years and you sell them for Rs. 1,27,000/-in 2015. You make a gain of Rs. 27,000/-Now your purchase price will be calculated as under by indexation method

Purchase cost Rs. 1 Lakh in year 2012

 

Inflation indexed Cost  =

Index of year of Sale of Assets 1024 (For 2014-15) X Purchase Price of Assets 1,00,000/-

Index of Purchasing year of the Asset 852 (For 2012-13)

=  1,20,188/-

So by this method your purchase price has increased to Rs. 1,20,188/- and therefore your capital gains would be Rs. 6,812/-(Sale Price (1,27,000/-) – Cost inflation indexed cost (1,20,188/-)) at the rate of current tax 20% long terms capital gains you will pay a tax of Rs. 1,362/-

Now compare this to an fixed deposit with a bank you invest same amount, Rs. One Lakh and earn same 9% per annum. Your Income would Rs. 9,000/-P. A. and you will have to pay a tax of Rs. 2,700/- if you are in the highest income tax bracket @ 30%.therefore you pay total tax of Rs. 8,100/- for three years.

The message is clear here even at same rate of interest you gain more profit by investing in debt fund rather than in a fixed deposit.

 
ST Debt Fund Bank FD
Investment Rs. 1,00,000/- Investment Rs. 1,00,000/-
Return 9% Interest 9%
Gain Made Rs. 27,000/- Gain Made Rs. 27,000/-
Capital Gain Tax Rs. 1,362/- Tax Rs. 8,100/-
Total Profit Made on the Investment Rs.(27,000/-Tax 1,362/-=25,638/-) Total Profit Made on the Investment Rs.(27,000/- 8,100 = 18,900/-)
 

Note- for ease of understanding we have taken simple interest calculation in above example.

For your use as Ready Reckoner we are providing you with Govt. announced inflation index table as below you can use it to calculate tax whenever you sell any asset.

 
Financial Year Cost Inflation Index
1981-1982 100
1982-1983 109
1983-1984 116
1984-1985 125
1985-1986 133
1986-1987 140
1987-1988 150
1988-1989 161
1989-1990 172
1990-1991 182
1991-1992 199
1992-1993 223
1993-1994 244
1994-1995 281
1995-1996 281
1996-1997 305
1997-1998 331
1998-1999 351
1999-2000 389
2000-2001 406
2001-2002 426
2002-2003 447
2003-2004 463
2004-2005 480
2005-2006 497
2006-2007 519
2007-2008 551
2008-2009 582
2009-2010 632
2010-2011 711
2011-2012 785
2012-2013 852
2013-2014 939
2014-2015 1024