The total rise in prices of goods and services over time in an economy is referred to as inflation. Money loses purchasing power due to inflation; therefore, over time, a given amount of money will be able to purchase fewer products and services. For instance, tomorrow's inflation can mean that, even if you bought two units of products for Rs 100 today, there might only be one unit available for Rs 100. Now let’s learn what the cost inflation index or CII is and the various other aspects related to this term in detail.

Cost Inflation Index Meaning

The long-term capital gains from the sale or transfer of a capital asset are computed using a Cost Inflation Index table. Capital gain is the money made from the sale or transfer of any of the capital assets, including real estate, stocks, shares, trademarks, patents, and so forth.

Usually, long-term capital assets are recorded in books at the cost. Because of this, these capital assets cannot be revalued even in the face of rising asset values.

Because of their high sale price in comparison to their acquisition price, these assets yield a significant profit or gain when they are sold. Assessees are, therefore, required to pay a high-income tax on the gains from these assets.

Over time, the utilisation of the Cost Inflation Index for capital gains modifies the acquisition cost of assets by considering their sale price, leading to reduced profits and a reduced tax liability.

Advantages of Using CII

1. Accurate Calculation of Capital Gains

CII aids in the correct calculation of capital gains by accounting for the effect of the CPI inflation rate on an asset's value. This guarantees that people don't pay more taxes than they should.

2. Tax Savings

Individuals' tax obligations can be lowered via CII by reducing their capital gains. They will, therefore, be able to retain a larger portion of their earnings, which is always a plus.

3. Reduced Paperwork

Because CII assists in modifying acquisition or improvement costs, it lessens the requirement for keeping copious documentation. Individuals can now compute their gains and taxes more easily.

Cost Inflation Index Table from FY 2001-02 to FY 2023-24

The Cost Inflation Index Table for the Base Year (Financial Year 2001–2002) to FY 2023–24 is provided here:

How is the Cost Inflation Index Used in Income Tax?

In books, long-term capital assets are listed at cost. They cannot be revalued; they exist at cost price, notwithstanding rising CPI inflation. Because the sale price of these assets is larger than the acquisition price, the profit margin is still large when they are sold. Moreover, this raises income taxes.

Long-term capital assets are subject to the cost inflation index, which raises the purchase price and lowers earnings and taxes for the benefit of taxpayers. The cost inflation index benefit is applied to long-term capital assets for the advantage of taxpayers; as a result, purchase costs rise, lowering profits and tax revenues.

How is CII Calculated?

The Cost Inflation Index Formula, which accounts for the inflation rate for a given year, is used to calculate CII. The following is the formula:

CII is equal to (current CPI rate of current year/inflation rate of the base year) × CII of the base year.

For instance, the CII for that specific year would be determined as follows if the base year is 2001–2002, the current year's inflation rate is 6%, and the base year's inflation rate was 4%.

150 is CII (6/4) x 100.

What is the Purpose of CII?

Long-term capital assets, such as machinery, are listed by a corporation on its balance sheet at their cost. But as time goes on and inflation rises, these capital assets' current worth can rise too, making it impossible to revalue them in the accounting records.

Long-term capital gains are sustained when a company or an individual sells capital assets because the sale price exceeds the original cost. Because of this, the assesses long-term capital gains tax liability is increased for the profit amount.

The formulation of the Cost Inflation Index likewise covers capital gains. It modifies the capital asset acquisition cost based on the sale price. In order to avoid paying more taxes, the procedure enables assessees to demonstrate lower long-term capital gains.

The Bottom Line

In particular, when it comes to capital gains, CII is an important component of taxation. It guarantees that taxes are computed fairly and precisely and aids in assessing the effect of inflation on the value of an item. Utilising CII can help people reduce their tax liability and paperwork load. To make wise choices about investments and taxes, one must be aware of CII and its ramifications.