What is Indexation?
Indexation is a technique to adjust income payments by means of a price index, in order to maintain the purchasing power of the public after inflation. Indexation adjust tax payments by employing a price index which adjusts for inflation. In other words, indexation is the process that takes into account inflation from the time you bought the asset to the time you sell it.
Indexation benefit for debt funds:
- Long term capital gains (held over a year) on debt funds suffer a 10% tax without indexation or 20% with indexation benefit. In the case of latter, by indexing, you bring your cost of investment to the current value, after factoring general price rise for consumers.
- Given that capital gains index has been expanding at a good pace (see table below), courtesy inflation, using the index will likely ensure that you pay very little tax or nil tax on your gains.
|Financial year||Cost Inflation Index||Financial Year||
Cost Inflation Index
Let us take an example of a
But if you index the cost of the same with CII for 2010-11 and 2011-12 and 2012-13,then the cost would be 10,853.5(10,000*852/785).So your gain,for tax purposes,would be Rs 46.5(10,900-10,853).A 20% tax on 46.5 will be just Rs 9.3.
With the same return,you may not even have to pay tax if you held the fund for say 2 years or 3 years,as the post-indexation cost will be higher than your sale value.