Since the global economy is dynamic and changes frequently, a unique tool called cost inflation index (CII) calculates the estimated increase per year in the price of an asset due to inflation. CII is mainly used for matching the inflation rate prices, i.e., the increased inflation rate will result in an increased cost of an asset. 

The central government fixes this inflation index, defined under the Income Tax Act’s Section 48.

For the calculation of CII and CII tax, the base year was earlier considered to be 1981-82. However, due to the challenges faced during proper and accurate valuations, the base year was changed to 2001.

A CII table helps calculate the long-term capital gains resulting from the sale or transfer of any assets. Here, capital gains are the profits received after taking these actions for an asset, including property, land, stocks, debt mutual funds, patents, etc. 

Let’s look more closely at cost inflation index benefits, how to calculate indexation, and other details regarding CII.

Cost Inflation Index explained

Cost Inflation Index refers to an accounting tool that various contractors utilise for adjusting the price contingency amount that the construction contracts include. CII is expressed as a percentage or ratio and is used for adjusting the contract price equitably for changes in the general price levels.

The CII is widely used by owners, designers, contractors, and other parties involved in the construction sector to measure how much inflation affects the cost of buildings from time to time. 

Cost Inflation Index benefits

This is how you can benefit from the notified cost inflation index:

• CII helps lower the price contingency of a project and saves costs for the contractor. It also permits the contractor to recoup lost earnings through price adjustment.
• CII lets an owner understand the effects inflation has on their project. 
• With the baseline period generally reflecting the values when the contract is signed, it helps to adapt to the change in labor and material costs. 

Cost Inflation Index India – Things to note

A few key points should be taken into consideration in the calculation of the indexed costs for asset purchase:

• If an asset comes at the will of an assessee, CII shall be taken into account for its year of receipt. The actual buying year of the asset should then be ignored.
• Any costs of improving the indexation before 1 April 2001 cannot be made viable.
• Indexation benefits do not apply for bonds other than sovereign gold or indexing bonds issued by the Reserve Bank of India (RBI).

How to calculate indexation?

If the general construction expenses increase at a rate different from that of the unit price, CII helps correct or adjust the price included in the construction contract. It is usually calculated as:

CII = [Current Unit Price / Base Period Unit Price] x 100%

The year in which sub-contractors commence negotiations on pricing with the owner is the base year in Cost Inflation Index. Consequently, this base period’s unit price is utilised to adjust future unit prices.

How does the income tax department use CII?

Long-term equity is documented in books at cost prices. They exist at cost prices and cannot be reassessed despite increased inflation. The profit amount remains large when sold because of the higher sales price than the buying price. This leads to an increase in income tax as well. CII applies to long-term capital assets, which increases purchasing costs and leads to less profit and lower tax for taxpayers. In favour of taxpayers, the profit from CII applies to long-term capital assets, which increases buying costs, leading to lower earnings and lower taxes.

When it comes to making mutual fund investment or planning to invest in stocks, having knowledge of CII could help you in getting an approximation of your returns and plan your investments wisely.