Detailed Explanation of Cost Inflation Index

Prices of goods rise over the period resulting in a reduction in the purchasing power of money.

For example -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.

CII is used for calculating the estimated increase in the prices of goods and assets year-by-year due to inflation.

Why is the Cost Inflation Index calculated?

Cost Inflation Index is calculated to unite the prices to the inflation rate. In simple words, an increase in the inflation rate over a period of time will begin to increase in the prices.

Who notifies the cost inflation index?

CG (Central Government) specifies the CII (cost inflation index) by notifying in the official gazette.

CII (Cost Inflation Index) = 75% of the rise in the Consumer Price Index* for the immediately preceding year.

*CPI (Consumer Price Index) relates the current price of a basket of goods and services 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 YearCost Inflation Index (CII)
2001-02 (Base year)100

Why has the base year of the Cost Inflation Index changed to 2001 from 1981?

Originally, 1981-82 was considered as the base year. But, taxpayers were facing difficulties in understanding the properties valued which were purchased before 1st April 1981. Tax authorities were also obtaining it difficult to rely on the valuation reports.

Hence, the government decided to shift the base year to 2001 so that valuations can be done immediately and correctly.

So, for a capital asset purchased before 1st April 2001, taxpayers can take higher of actual cost or FMV as on 1st April 2001 as the purchase price and avail benefit of indexation.

Practical Examples

Case 1: Mr.X purchased a flat in FY 2001-02 for Rs. 10,00,000. He sells the flat in FY 2018-19. What will be the indexed cost of acquisition?

In this case, 

CII for the year 2001-02 and 2018-19 is 100 and 280 respectively.

Hence, the Indexed Cost of Acquisition = 10,00,000 x 280/100 = Rs. 28,00,000

Case 2: Mr. Y Purchased a capital asset in FY 1995-1996 for Rs. 1,00,000. FMV of the capital asset on 1st April 2001 was Rs. 4,20,000. And sells the asset in FY 2016-17.

What is the ICOA (indexed cost of acquisition)?

Here, the asset is purchased before the base year.

Hence the COA (cost of acquisition) = Higher of actual cost or FMV (Fair market value) on 1st April 2001.

i.e. Cost of Acquisition = Rs. 4,20,000.

CII for the year 2001-02 and 2016-17 is 100 and 264.

Indexed cost of acquisition = 4,20,000 x 264/100 = Rs. 1,108,800.

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