Indexation is a crucial tax mechanism in India that adjusts the purchase price of an asset for inflation when calculating long-term capital gains (LTCG) tax. This ensures that taxpayers are taxed only on real profits, preventing inflated gains due to rising prices from increasing tax burdens unfairly. This is especially important in real estate, where inflation-driven price appreciation can distort tax liabilities.
The Cost Inflation Index (CII), published annually by the government, measures inflation and allows taxpayers to adjust an asset’s purchase price to reflect inflation, thereby reducing taxable gains. This adjustment ensures fair taxation based on actual value appreciation rather than nominal price increases.
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The indexed cost of acquisition is calculated using the formula:
Indexed Cost of Acquisition = (Original Purchase Price × CII of Sale Year) ÷ CII of Purchase Year
For properties acquired before April 1, 2001, the base year is set as April 1, 2001, with a CII of 100. This helps taxpayers determine a property’s fair market value as of that date and apply indexation accordingly.
Budget 2024 introduced a change by eliminating indexation benefits for LTCG on property sales for assets acquired after July 23, 2024. Taxpayers were given two choices:
Consider a taxpayer who sells a residential apartment for ₹50,00,000 on November 1, 2024. The property was originally purchased on May 1, 2000, with a fair market value of Rs15,00,000 as of April 1, 2001. Without indexation, the taxable capital gain appears significantly inflated.
Pariculars | New Regime (Without Indexation) | Old Regime (With Indexation) |
---|---|---|
Sale Price | ₹50,00,000 | ₹50,00,000 |
Indexed Cost of Acquisition | – | ₹54,45,000 |
Taxable Capital Gain | ₹35,00,000 | ( ₹4,45,000) (Capital Loss) |
Capital Gain Tax Rate | 12.5% | Nil |
Tax Payable | ₹4,37,500 | Nil |
This plainly illustrates how the removal of indexation significantly inflated tax liability, punishing property sellers.
The elimination of indexation triggered widespread criticism from taxpayers, industry leaders, and tax experts regarding the disproportionate burdening of long-term property holders and threatened market stability.
Recognising these concerns, the Government amended Section 112 of the Income Tax Act, 1961, through the Finance Bill 2024, reinstating indexation benefits for properties acquired before July 23, 2024. The revised options are now:
This policy correction was a necessary step to restore investor confidence and align taxation with economic growth objectives.
A property purchased in the financial year 2002-03 for ₹25,00,000 and sold in the financial year 2023-24 for ₹1,00,00,000 highlights the value of indexation:
Position | Taxable LTCG | Tax Rate | Tax Liability |
---|---|---|---|
With Indexation | ₹17,14,285 | 20% | ₹3,42,857 |
Without Indexation | ₹75,00,000 | 12.5% | ₹9,37,500 |
While the tax rate without indexation appears lower, the taxable gain is significantly higher, leading to a 172% increase in tax liability.
The elimination and subsequent reinstatement of indexation in India’s tax system highlight the importance of aligning fiscal policy with investor confidence. While the initial move aimed at simplifying taxation, it inadvertently created significant difficulties for property investors. The reinstatement of indexation through the amendment of Section 112 of the Income Tax Act represents a necessary course correction to ensure fair and growth-oriented taxation.
As India moves forward with economic reforms, consistency and transparency in tax policies will be crucial. A stable and investor-friendly taxation framework will encourage long-term investments, drive economic growth, and create a more equitable financial environment for all stakeholders.
This article was originally published in Mint on 31 January 2025 Written by: Ashoo Gupta, Partner. Click here for original article
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