Prices of goods increase over time resulting in a fall in the purchasing power (quantity of goods that one unit of money can buy) of money.
If 2 units of goods could be bought for Rs.100 today, tomorrow only 1 unit might be available for Rs. 100 due to increasing inflation.
Cost Inflation Index (CII) is used for calculating the estimated increase in the prices of goods and assets year-by-year due to inflation.
Why is Cost Inflation Index calculated?
Cost Inflation Index is calculated to match the prices to the inflation rate. In simple words, an increase in the inflation rate over a period of time will lead to an increase in the prices.
Who notifies the cost inflation index?
Central Government specifies the cost inflation index by notifying in the official gazette.
Cost Inflation Index = 75% of the average rise in the Consumer Price Index* (urban) for the immediately preceding year.
*Consumer Price Index compares the current price of a basket of goods and services (which represent the economy) with the price of the same basket of goods and services in the previous year to calculate the increase in prices.
What is the current Cost Inflation Index?
|Financial Year||Cost Inflation Index (CII)|
|2001-02 (Base year)||100|
How is Cost Inflation Index used in Income Tax?Long-Term Capital Assets are recorded at cost price in books. 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.
To benefit the taxpayers, cost inflation index benefit is applied to the long-term capital assets, due to which purchase cost increases, resulting in lesser profits and lesser taxes.
What is the concept of base year in Cost Inflation Index?
The base year is the first year of Cost Inflation Index and has index value as 100. Index of all other years is compared to base year to see the increase in inflation percentage.
For any capital asset purchased before the base year of Cost Inflation Index, taxpayers can take the purchase price as higher of the “actual cost or Fair Market Value (FMV) as on 1st day of the base year. Indexation benefit is applied to the purchase price so calculated.
FMV is based on the valuation report of a registered valuer.