# What Is the Cost Inflation Index? – Definition, Charts, and Calculation

Are you tired of hearing the word ‘Inflation’? Is it bothering you that it will eat a pie of your investment returns? If yes, well, you are not alone. Inflation is an integral part of the global economy, and one cannot go without the other. While controlling inflation is not possible at the individual level, certain measures can help you make the most of your investment. The Cost Inflation Index (CII) is an estimated year-on-year increase in asset price. It helps you to adjust your investment assets with the inflation rate so that your gains are not eroded.

## What Does the Cost Inflation Index Mean?

Cost inflation index or CII is notified under the IT act, section 48. It is a simple way of calculating inflation, which is an estimated increase in the price of any goods or service over the years. Hence, the cost that is adjusted for inflation is said to be indexed.

CII is calculated using the base year index value like any other economic variable. Its value is set at 100, and the value in subsequent years helps in checking the rise in inflation. The central government publishes this index on an annual basis. For calculating this index, long-term capital gains are also considered. These are gains arising from the sale of capital assets like land, stocks, bonds, etc.

Let’s understand it in a simple way. Suppose you buy a house today and sell it after 5 years. The price of the house will increase, but inflation, too, increases with time. Thus, you need to adjust your selling price of the house to count inflation. Doing so reduces your gains from the sale of the house as the capital gains reduce. CII is quite crucial for this.

## What Is the CII’s Purpose?

In simple words, CII  tells you the increase in the prices of capital assets that you are holding. Capital gain helps to decipher the actual gain that resulted from the holding period until the asset is sold. Ideally, the cost price is taken at book value and is not readjusted. Hence, at the time of selling those assets, you pay a higher tax from the gain of these assets.

With the CII, the purchase price of the asset is adjusted with the selling price considering inflation. This, in turn, results in lower taxes. To achieve accuracy here, the government keeps a tab on the base year and the inflation rate. The last change in the base year was done in 2018 to help investors save money on taxes and make the most of their asset valuation.

New cost inflation index numbers are applicable from 2017-18, and the base year 1981 is replaced with 2001, with 100 being the base value.

## What Is the Difference Between Old and New CII Numbers?

Now, let’s dive deep into new and old CII figures.

## Why Is CII Calculation Required, and How Is it Calculated?

CII calculation is required to know the real impact of inflation and indexation on your capital gains and taxation. Indexation refers to adjusting an asset’s price based on another indicator affecting the price–in this case, that is the inflation rate.

CII helps you to understand the price rise in your assets against the general inflation rate. It acts like verification and helps you to understand which goods and services are rising. Let’s say the price of 1 ltr. petrol costs Rs 90 today. What would be the price a week down the line as inflation and oil prices rise? To know this, CII plays a crucial role as it reflects the impact of inflation on goods, services, or assets.

These changes should be reflected in your capital gains and the tax you pay. To adjust the cost of inflation, the index used for indexation is CII. It helps in adjusting the price and gives the true picture. The prices of assets, like machinery, buildings, houses, etc., are inflation-adjusted to calculate your capital gains and tax liability.

The below formula is used to calculate the inflation-adjusted cost:

(CII at the time asset was sold / CII at the time asset was acquired) * cost price

### Example

For example, Mr. X bought land for Rs. 10 lakhs in the year 2017 and sold it for Rs. 15 lakhs in the year 2021. The profit made is Rs. 5 lakhs.

CII for the year 2017 was 272, and in the year 2021 was 301.

Hence, the CII = 301/272 = 1.106

Indexed cost, in this case, = (CII at the time asset was sold / CII at the time asset was acquired) * cost price

10,00,000 * 1.106 = 11,06,617.6

The cost price of the land increases by nearly Rs. 1 lakh. This means capital gains will be calculated at Rs. 3,93,383 lakh (15 lakhs – 11,06,617.6 lakhs). The change in cost price that is inflation adjusted reduced the tax liability for Mr. X.

## CII India: Important Points to Keep in Mind

While the calculation of CII seemed easy, there are a few points to bear in mind before calculating the indexed cost:

• If you receive an asset as a part of a will, CII will be evaluated based on the year in which the asset is received. Hence, the asset’s actual year of purchase is ignored.
• There are improvement costs for the assets, and hence any of these costs prior to 1st April 2001 are not viable for indexation.
• Benefits of indexation do not apply to bonds or debentures unless they are RBI-issued indexation bonds or SGBs.
• Equity and equity-related mutual funds are not eligible for indexation benefits. The gains and losses arising from them are calculated normally.

## Conclusion

CII has great utility in calculating inflation-adjusted costs for certain assets that are eligible for indexation benefits. All you need to do is do some research, apply the benefits of indexation, and save on your tax liability. However, you should remember that equity/equity mutual funds do not come under this head. Apart from that, CII is a great way to reduce tax liability and to know how the asset value increases over time.

## FAQs

### 1. What does the CII base year mean?

The base year is the first year in the index, with a value set at 100. Hence the base year helps in the indexation of the years following the base years to know the increase in asset price.

### 2. How can the Cost Inflation Index (CII) aid in the calculation of capital gains?

Firstly, capital gains arise only when the sale of an asset is made at a higher price than it was acquired. Since the purchase price goes back many years, adjusting it for inflation allows the taxpayer to account for inflation. Hence, resulting in a higher cost of the asset and thereby lowering the capital gains to reduce the tax liability.

### 3. Are capital gains with a short duration eligible for indexation?

No, you cannot claim short-term capital gains for indexation. If long-term capital gains do not apply, the cost price cannot be adjusted for inflation. It is also not applied to equity and equity-based mutual funds.

### 4. How is CII applied to assets acquired prior to the base year?

Let’s say an asset was acquired before 2001, i.e., the base year. In this case, the asset price can be higher than a) the fair market value (FMV) of an asset or b) its actual cost (price at which it was purchased). These prices are compared on the first day of the base year (2001). Once you arrive at the cost, an indexation benefit can be applied.