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Know how to save income tax through cost inflation index

Tax guru Subhash Lakhotia explains on how one can save tax expenditure on property gains through cost inflation index methods. He points that it saves substantial amount of income tax on long term capital gains.


Subhash Lakhotia ( more)

Tax & Investment Consultant


Subhash Lakhotia

It is really possible to save substantial amount of income-tax on your long-term capital gains arising out of selling your immovable property, if you take advantage of the cost inflation index concept. However, it is applicable only in long-term capital gains.

Also read: Do not miss out on fixed income interest

Only when you hold your property for more than 36 months and sell it, the profit is known as long-term capital gain. You can save by resorting to the theme of cost inflation index.

The long term capital gains for all types of assets including long-term property gains for all assesses would be computed in the following manner:

1. Cost of acquisition of the asset, whether movable or immovable, is to be multiplied by the cost inflation index of that year in which the asset is transferred. The resulting figure is to be divided by the cost inflation index for the year in which the asset was acquired.

If, the asset was purchased before April 1, 1981, the cost inflation index for the purpose of acquisition is to be taken as the one on April 1, 1981.

2. Any cost incurred on the improvement of an asset is to be similarly adjusted with the help of the cost inflation index, i.e. by multiplying the cost of improvement by the cost inflation index of the year in which the asset is transferred.

It has to be then divided by the cost inflation index for the year in which the asset is transferred, and be divided by the cost inflation index for the year in which the improvement to the asset was done.

The Government has notified the cost inflation index for various financial years from 1981-82 to 2013-2014, the table of cost inflation index for the different financial years is given on next page:

For the financial year, 2013-2014 relevant to AY 2014-2015 the net capital gain tax payable by an assessee in respect of long-term capital gains is calculated on the basis of the above cost inflation index.  It may also be remembered that the benefit of cost inflation index is not available for short-term capital gains or losses. 

Thus, selling property (land, house, flat, etc.) within a period of less than three years from the date of its purchases  is treated as a short-term capital gain or loss in respect of gain from property.  Thus, the above cost inflation index will be of no use to a person deriving  either a short-term  capital gain or loss. 
So, too, the benefit of the cost inflation index is not available to non-resident Indians.

Apart  from the adjustments arising from the cost inflation index the various expenses incurred on improvements to the asset, and on transfer of the asset for example  stamp duty, legal fees payment of brokerage, etc. are deductible from the full value of the sale consideration. 

It is the net resultant figure which will be treated as a long-term capital gain or loss chargeable to income-tax in terms of Section 112 of the Income-tax Act.

For the actual year 2014-2015 the tax on long-term capital gains payable is 20 percent.  Thus, tax payment in respect of long-term capital gains is much lower than what has been prescribed by the Income-tax Act, if we take into account the impact of the cost inflation index. 

This is explained by the following illustrations:

Illustration No.1

Shyam purchased property for Rs 10,00,000 in the year 1981. He sold this in the financial year 2013-2014 for Rs 38,00,000.  The long-term capital gain would be calculated as under :

Cost of acquisition for the purpose of capital gains
= {Cost of acquisition x Cost inflation index of the year of transfer}
÷ {Cost of inflation Index of the year in which purchased}
= {10,00,000 X939/100 Rs.93,90,000}
In this case, the selling price is lower than the cost of acquisition as computed with reference to the cost inflation index [Rs 93, 90,000]

Hence, there will be no capital gains tax payable, rather, there will be a long-term capital loss to the tune Rs 55,90,000 which can be carried forward for adjustment against Shyam’s  total  long-term capital gains.

Illustration No.2

Anurag purchased flat for Rs 20 lakh during the financial year 1991-92 and sold it for Rs.96  Lakhs on 25-7-2013.

Normally, the capital gains should have been Rs.70 lakh  but in view  of the adjustments on account of the cost inflation index, the capital gains  would be calculated as under :

{ 20,00,000 x 939/199 = Rs.94,37,185}
[Cost  inflation index for 1991-92 = 199]

Thus, in this case, the long-term capital gains  would be calculated as under :
Sale Price                                                                         = Rs 96,00,000

Less: Adjusted cost price taking into                                    =  Rs 94,37,185
account the impact  of cost inflation index

Long-term capital gains.                                                      =  Rs 1,62,815

Illustration No.3

Neelam purchased a piece of land during the financial year 1989-90 for Rs. 6 lakh.  She sold  it for Rs.40 lakh in Financial Year 2013-2014  (A.Y : 2014-2015).  Normally, the capital gains would have been Rs.36 lakh but in view of cost inflation index, the capital  gains would be calculated in the following manner :

6,00,000 X 939 (cost inflation index for 2013-2014)

172 (Cost inflation index for 1989-90)                 =   Rs. 32,75,581

The long-term capital gains as a result of cost inflation index adjustment would be as under :

Sale Price                                              =  Rs. 40,00,000

Less: Adjusted cost price as per              =  Rs. 32,75,581

Cost Inflation Index    ______________
Long-term capital gain                             =  Rs.  7,24,419   

Illustration No. 4 :

Pranab Kumar purchased property on 1st February, 2013 and sold the same on 16-8-2013.  The cost price was Rs.22 lakh and the sale price Rs.26 lakh, thus  the profit  is Rs.4 lakh.

As this is  a short-term capital gain, the benefit of cost inflation index is not available and Mr. Kumar is liable  to pay tax at the normal rate.

As shown by the above calculations and illustrations, in most cases the assessee will benefit to a very large extent as a result of cost inflation index.

Financial Year Cost inflation index
1981-82 100
1982-83 109
1983-84 116
1984-85 125
1985-86 133
1986-87 140
1987-88 150
1988-89 161
1989-90 172
1990-91 182
1991-92 199
1992-93 223
1993-94 244
1994-95 259
1995-96 281
1996-97 305
1997-98 331
1998-99 351
1999-00 389
2000-01 406
2001-02 426
2002-03 447
2003-04 463
2004-05 480
2005-06 497
2006-07 519
2007-08 551
2008-09 582
2009-10 632
2010-11 711
2011-12 785
2012-13 852
2013-14 939