Cost Inflation Index

A flat bought for Rs 50 lakh in 2002 and sold for Rs 3.5 crore today has not made Rs 3 crore of real profit. A large part of the rise is simply that rupees are worth less than they were.

Indexation is the Income Tax Act's way of removing that part before taxing what remains. The Cost Inflation Index is the number series that does it: the CBDT notifies a figure for each financial year, with 2001-02 set at 100, and the original cost is scaled up by the ratio of the two years' indices.

What is left after indexation is the gain in real terms — and only that is taxed.

The Finance Act, 2024 changed when indexation is available, and this is now the most examinable part of the topic.

Transfers before 23 July 2024 — indexation is available on all asset classes, barring certain exceptions.

Transfers on or after 23 July 2024 — indexation is not available, except for land or building or both acquired before 23 July 2024.

For that surviving exception the workbook sets out a parallel test. If immovable property was acquired before 23 July 2024 but transferred after it, compute the tax both ways — at 20% with indexation, and at 12.5% without — and the lower tax applies. One restriction rides with it: any loss created by indexation is no longer allowed.

Where the property was acquired after 23 July 2024, there is no choice at all: 12.5% on the unindexed gain.

A second rule sits underneath the formula: the denominator is the CII of the year the asset was first held by the assessee, or of 2001-02, whichever is later. An asset bought in 1994 is indexed from 2001-02, not from 1994.

                          CII of the year of transfer
Indexed cost      =  Cost x ---------------------------------------
of acquisition               CII of the year the asset was first held
                             by the assessee, or CII of 2001-02,
                             whichever is LATER

Selected notified values: 2001-02 = 100, 2002-03 = 105, 2011-12 = 184, 2014-15 = 240, 2020-21 = 301, 2023-24 = 348, 2024-25 = 363.

The workbook's own case. A Mumbai house cost Rs 50,00,000 in FY 2002-03 (CII 105) and is transferred in FY 2020-21 (CII 301):

Indexed cost = 50,00,000 x 301 / 105  =  Rs 1,43,33,333

The cost has nearly trebled on paper without a rupee being spent — and Rs 93 lakh of apparent gain has just disappeared from the tax base.

The post-23-July-2024 parallel test. A flat bought in FY 2011-12 for Rs 40,00,000 (CII 184) is sold on 1 December 2024 — FY 2024-25, CII 363 — for Rs 1,60,00,000. It was acquired before 23 July 2024 but transferred after, so both routes must be computed.

The lower tax is Rs 15,00,000, so the unindexed route applies — even though indexation removed Rs 39 lakh of gain. The lower rate beat the larger deduction. That inversion is exactly what the examiner is testing: the taxpayer does not choose the method, the arithmetic does.

Chapter 8 (Capital Gains), section 8.5 covers the indexed cost of acquisition, the CII formula and the 23 July 2024 cut-off, and Annexure 3 prints the full notified table. Chapter 10 and Chapter 12 then apply the no-indexation rule to debt products, gold and property. Expect a computation: you will be given a purchase year, a sale year and two index values, and asked for the indexed cost or the tax — and increasingly, asked to run the parallel calculation and say which answer stands.

• The base year is 2001-02, not the year of purchase. An asset acquired in 1996 uses the CII of 2001-02 in the denominator, so pre-2001 inflation is never indexed.
• Indexation is largely gone for transfers on or after 23 July 2024 — the only survivor is land or building acquired before that date. Applying the old rule to a mutual fund or a bond is a marks-losing habit.
• The parallel calculation compares tax, not gain. A smaller gain at a higher rate can still be the worse answer, as above.
• A loss produced by indexation is not allowed. Indexation can reduce the gain to nil; it cannot manufacture a deductible loss.
• Cost of improvement is indexed separately, from the year the improvement was incurred, and only capital expenditure on or after 1 April 2001 counts at all.
• CII is not household inflation. It is a notified tax figure. Do not use it as an inflation assumption in a retirement plan, or a general inflation forecast in a capital gains computation.