BTL 799 - Indexation

 

The Banking Tutor’s Lessons

BTL 799                                                                   30-06-2025

Indexation

Indexation is a method used to adjust the purchase price of an asset for inflation when calculating capital gains tax. 

It increases the cost of the asset to reflect the impact of inflation over time, which can lead to a lower taxable capital gain. This is particularly relevant for long-term capital gains, especially in debt mutual funds.

Indexation aims to provide a more accurate reflection of the real profit (or capital gain) made on an asset by accounting for the effects of inflation. 

It involves using a Cost Inflation Index (CII) to adjust the purchase price of an asset. The CII is a government-notified index that reflects the rate of inflation.

Benefits: 

By increasing the cost of the asset, indexation reduces the taxable capital gain, resulting in a lower tax liability. 

Indexation is commonly used in the context of mutual funds, particularly debt mutual funds, where it can significantly reduce the tax burden on long-term capital gains.

Example: If you bought a mutual fund for Rs 100,000 and sold it for Rs 150,000 after a few years, the capital gain would be Rs 50,000. However, if you apply indexation, the purchase price might be adjusted to Rs 120,000 (for example) due to inflation. This would reduce the taxable capital gain to Rs 30,000. 

Long-term capital gains: Indexation is most beneficial for long-term capital gains, as the effect of inflation is more pronounced over a longer period. 

Sekhar Pariti

+91 9440641014