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What is Indexation?

Are you getting benefits from the indexation?

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:

  1. 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.
  2. 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

1981-1982 100 1997-1998 331
1982-1983 109 1998-1999 351
1983-1984 116 1999-2000 389
1984-1985 125 2000-2001 406
1985-1986 133 2001-2002 426
1986-1987 140 2002-2003 447
1987-1988 150 2003-2004 463
1988-1989 161 2004-2005 480
1989-1990 172 2005-2006 497
1990-1991 182 2006-2007 519
1991-1992 199 2007-2008 551
1992-1993 223 2008-2009 582
1993-1994 244 2009-2010 632
1994-1995 259 2010-2011 711
1995-1996 281 2011-2012 785
1996-1997 305 2012-2013 852

 

Let us take an example of a debt fund,say an income fund,that you bought for Rs.10,000 in 2011-12.If the fund returned 9 and you sell it for Rs 10,900,your long term capital gain would normally be Rs 900.A 10% tax on this plus cess would be Rs 93.

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.

                                                                                         

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