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A Brief Note on Cost Inflation Index (CII) for FY 2021-22 (AY 2022-23)

The price of a product increases overtime, and this brings down the purchasing power of money. The phenomenon of a reduction in the value of money, which leads to an increase in an individual’s cost of living, is known as inflation. The Cost Inflation Index is basically a tool which measures the effect of inflation on the value of money over a period of time.Cost Inflation Index (CII) is used to estimate the increase in the prices of goods and assets year-by-year due to inflation.The Central Government fixes this index and publishes it in its official gazette for measuring inflation. Section 48 of the Income Tax Act, 1961, defines the index as notified by the Government every year.

Under Income Tax the CII is used to adjust the cost of the capital asset over a period of time due to inflation. The value of capital asset derived by using CII is known as the inflation adjusted purchase price of assets. The capital gain is computed by taking into consideration the adjusted price of the capital asset.

The Central Board of Direct Taxes every year notifies the Cost Inflation Index rate. This year the Cost Inflation Index (CII) has been notified by the Ministry of Finance. The Finance Minister stated that CII for FY 2021-22 has been set as 317. For the previous financial year, i.e. 2020-21 CII was 301.

Purpose of Cost Inflation Index:

• A Cost Inflation Index table is used to calculate the long term capital gains from a transfer or sale of capital assets. Capital gain refers to the profit acquired from the sale/transfer of any capital assets, including land, property, stocks, shares, trademarks, patents, etc.
• In the books of accounts of the assessees long term capital assets are recorded at historical cost.
• At the time of sale of these assets, the profit or gain acquired from them remains high due to their high sale price in comparison to their purchase price. As a result, assessees also have to pay a higher income tax on the gains from these assets.
• With the application of Cost Inflation Index for capital gain, in the long run, the purchase price of assets is adjusted according to their sale price, leading to lower profits and lower tax amount on them. Hence, the implementation of CII is beneficial for the assessees.

Concept of Base Year:

• The ‘Base Year’ is the year from which the CII table starts.
• In other words it is the very first year of the Cost Inflation Index.
• The value of base year is always assumed to be 100. The index of all other years is expressed as a percentage of the base year.

Shift in Base Year from 1981 to 2001:

• Earlier, 1981-82 was regarded as the base year. However, addressing the technical difficulties faced by valuers and tax authorities, the Government decided to shift the base year to 2001-02, so that valuations can be done faster and accurately.
• The Central Board of Direct Taxes in February 2018 notified new Cost Inflation Index numbers applicable from 2017-18 onwards.
• In this revision, there was a shift from the old base year of 1981 to 2001, with 100 taken as its CII. The indices for subsequent years were also revised accordingly.
• In case of capital assets bought before April 1, 2001, taxpayers can take higher of actual cost or fair market value as on April 1, 2001, as the purchase price and enjoy the benefit of indexation.Changing the base year helps capture the property's inflated cost in a better manner, bringing down the capital gains and the tax burden.

Old Cost Inflation Index (Applicable from FY 1981-82 to FY 2016-17):

New Cost Inflation Index applicable from 1st April 2017 onwards:

• In order to revise the base year for computation of capital gains, section 55 of the Income Tax Act, 1961 was amended vide Finance Act, 2017 so as to provide that the cost of acquisition of an asset acquired before 1st April 2001 shall be allowed to be taken as fair market value as on 1st April, 2001 and the cost of improvement shall include only those capital expenses which are incurred after 01.04.2001.
• Cost inflation index for Long Term Capital Assets sold after 1st April 2017 as notified by CBDT Notification No. 44/2017 dated 05.06.2017 shall be as under:

Indexed Cost of Acquisition:

• Long-Term Capital Assets are recorded at historical cost in books of accounts. Despite increasing inflation, they exist at the cost price and cannot be revalued. When these assets are sold, the profit amount remains high due to the higher sale price as compared to purchase price. This also leads to a higher income tax.
• The cost inflation index is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes to benefit taxpayers. This increased purchase cost of asset is known as Indexed Cost of Acquisition.
• For the computation of the indexed cost of Acquisition of a property, the seller needs to multiply the property's cost of acquisition with the Cost Inflation Index, as notified by the tax authorities for the year of transfer.
• This figure then has to be divided by the cost inflation index of the year of purchase.

Formula:

Indexed Cost of Acquisition=Acquisition Cost of Asset X CII for the year of Sale / CII for the year of Purchase

Note: But, should the property be purchased prior to the base year of cost inflation index, one needs to know the property's fair market value for the base year.

Indexed Cost of Improvement:

Indexed Cost of Improvement =

Actual Cost of Improvement of Asset X CII for the year of Sale / CII for the year of Improvement

Example:

Indexed Cost of Acquisition=Rs. 30,00,000X 280 / 113=Rs. 74,33,628

Other Important Notes:

• If an asset is received by will, CII is considered for the year in which it is received. In this case, the asset’s actual purchase year is to be ignored.
• Any improvement cost incurred before April 1st 2001 is not viable for indexation.
• Benefits of indexation are not applicable for debentures or bonds, apart from RBI issued sovereign gold bonds or capital indexation bonds.