Ashish and Ajay were watching the news about the Cost Inflation Index for 2023-24 and the following conversation unfolded
Ajay: Hey, what is this CII?
Ashish: Cost Inflation Index is a number released by the Income tax department every year based on the inflation for the year. It is used to calculate the indexed cost of acquisition of assets; which, in turn, helps assess the long-term capital gain.
Ajay: What is this indexation, why so much fuss if it is not allowed for debt mutual funds?
Ashish: The purchasing power of money declines over a period, therefore the cost of acquisition in the past needs to be adjusted to as what it would be today i.e., when the asset is being sold; and the amount excess of the adjusted cost of acquisition is the capital gain.
The first year in the CII table is called base year whose value is 100. The numbers for other years in the table are the value of base year in that particular year. The indexed cost of acquisition is calculated as the cost of acquisition divided by the CII of the year of acquisition multiplied by the CII of the year of sale.
Debt mutual funds held for three years were eligible for indexation benefit on redemption but now, with this benefit gone, the net proceeds on redemption will be taxed at the slab rate of the investor.
Ajay: Ok, but it’s still not clear.
Ashish: Ok, consider this. You bought a plot in the year 2015-16 for ₹10 lakh and sold it in 2023-24 for ₹50 lakh, this is an LTCG transaction. If there is no indexation benefit, then the applicable tax rate of 20 per cent and 4 per cent cess will be calculated on ₹40 lakh (₹50 lakh less ₹10 lakh) which will be ₹8.32 lakh. However, if indexation benefit is given, then the cost of acquisition will not be ₹10 lakh but ₹13.7 lakh (CII of 2015-16 is 254 and CII of 2023-24 is 348). Therefore, the capital gain will be ₹36.3 lakh and the tax liability will be ₹7.55 lakh at the same tax rate, which is ₹76,900 lower.
Ajay: Oh! Now I get it. Indexation reduces the tax bill of investors, therefore its removal for debt funds is negative for investors.
Also read: Cost Inflation Index for calculation of long term capital gain for FY24 fixed at 348