Indexation — Restored or Redesigned?
It has been nearly a year since the Finance (No. 2) Act, 2024, reshaped the Indian tax landscape, and yet, one provision continues to spark debate among tax professionals and taxpayers alike — ‘The Indexation’. While the Act spanned reforms across personal income tax, corporate taxation, green initiatives, and digital compliance, the most significant and far-reaching impact has arguably emerged in the domain of capital gains taxation, which has seen a historic shift in both computation and taxation.
The Finance Bill (No. 2), 2024, had proposed to withdraw the indexation benefit altogether. However, what eventually found its way into the final Act was more calibrated: a tax liability cap that simulates relief.
It may look like indexation has returned — but has it, really?
Evolution of Indexation: A Quick Recap
The concept of indexation has matured significantly since its inception in Indian tax law. It was first implemented in the 1992 Budget, following recommendations from the Raja Chelliah Committee, which sought to rationalise the taxation of long-term capital gains (LTCG) by accounting for inflation. The government introduced the Cost Inflation Index (CII), with 1981-82 as the base year (index value = 100), allowing taxpayers to adjust the cost of acquisition and improvement for inflation. This ensured that only real gains and not nominal increases, due to inflation, were taxed. In 2001, the government shifted the base year for indexation from 1981 to 2001 to simplify valuation and align it with more accessible historical data.
More recently, the year 2024 saw a significant policy shift, with the gradual withdrawal of indexation benefits culminating in the Finance (No. 2) Act, 2024, which eliminated indexation for all capital assets in gain computation.
But a pertinent question remains: Even after its withdrawal, does indexation persist in a different form?
Demystifying the Concept
At first glance, the final provisions led to a wave of optimism among taxpayers and professionals, with many interpreting them as a revival of indexation for long-term capital gains (LTCG). This perception stemmed from the shift between the original Finance Bill, which had proposed a complete withdrawal of indexation, and the enacted law, which introduced a tax liability cap on the sale of land & buildings by resident individuals and HUFs.
But as is often the case in taxation, the devil lies in the details. The truth is more nuanced and a bit trickier than what the headlines suggest.
Traditionally, Section 48 of the Income-tax Act, 1961, has governed the indexation in the computation of capital gains. It allowed for the deduction of the “indexed cost of acquisition” and “indexed cost of improvement” while calculating long-term capital gains. This often led to significantly reduced tax liability.
However, the Finance Act (No. 2), 2024, changed the rules of the game.
The second proviso to Section 48 is reproduced verbatim below:
“Provided further that where long-term capital gain arises from the transfer [(which takes place before the 23rd day of July, 2024)] of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words “cost of acquisition” and “cost of any improvement”, the words “indexed cost of acquisition” and “indexed cost of any improvement” had respectively been substituted:”
This makes it clear that for transfers on or after 23rd July 2024, indexation is no longer available for computing the capital gains.
Then, Why the Talk of “Restoration”?
This confusion stems from a new relaxation introduced under the second proviso to Section 112(1)(a). Section 112 of the Act governs the chargeability of Tax on long-term Capital Gains on all capital assets except listed equity shares of domestic companies, Units of Equity-oriented Mutual Fund, and Units of Business Trusts. The proviso attempts to cushion the impact of the withdrawn indexation benefit at the time of tax computation, though not for income inclusion.
Section 112(1) stipulates that — “Where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of, —
(a) in the case of an individual or a Hindu undivided family, being a resident, —
- the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been his total income; and
- the amount of income-tax calculated on such long-term capital gains, —
(A) at the rate of twenty per cent for any transfer which takes place before the 23rd day of July, 2024; and
(B) at the rate of twelve and one-half per cent for any transfer which takes place on or after the 23rd day of July, 2024:
Further, the second proviso to the above stipulates that,
“Provided further that in the case of transfer of a long-term capital asset, being land or building or both, which is acquired before the 23rd day of July, 2024, where the income-tax computed under item (B) exceeds the income-tax computed in accordance with the provisions of this Act, as they stood immediately before their amendment by the Finance (No. 2) Act, 2024, such excess shall be ignored;”
From this, we deduce that the benefit of indexation exists only for tax liability comparison, not for computing the actual capital gain. This relief allows assessees to effectively claim indexation “at the tax stage” if it results in lower tax payable, but not at the stage of income computation. It is pertinent to note that this relief is available only for sale by a Resident Individual or HUF of land or building or both. This relief is not available for Non-Resident Individuals, Companies, LLPs, Partnership Firms, etc.
The capital gain added to the Gross Total Income will not reflect any indexed cost. It’s not a return of indexation but a cleverly worded tax cap!
Illustration
Let’s break this down with an example covering different scenarios:
Mr. D, who is a resident, sells his Residential flat for a consideration of Rs 1,20,00,000. The dates of acquisition and sale for the 3 scenarios are listed below:
- Flat acquired on 1st April 2007 and sold on 22nd July 2024.
- Flat acquired on 1st April 2007 and sold on or after 23rd July 2024.
- Flat acquired on 24th July 2024 and sold on 1st April 2028.
He also invests ₹20 lakhs in another flat eligible for Section 54 exemption.
The Computation of Capital gains and tax under each Scenario is as follows:
| Particulars | Scenario 1 | Scenario 2 | Scenario 3 | |
|---|---|---|---|---|
| Sold before 23rd July 2024 | Bought before 23rd July and sold on or after 23rd July 2024 | Bought & sold after 23rd July 2024 | ||
| 20% Tax with Indexation | 12.5% Tax without Indexation (Option-I) | 20% Tax with Indexation (Option-II) | 12.5% Tax without Indexation | |
| Date of sale of flat | 22nd July 2024 | On or after 23rd July 2024 | On or after 23rd July 2024 | 1st April 2028 |
| Date of acquisition of flat | 1st April 2007 | 1st April 2007 | 1st April 2007 | 23rd July 2024 |
| Sale Consideration | 1,20,00,000 | 1,20,00,000 | 1,20,00,000 | 1,20,00,000 |
| Cost of Acquisition | 35,00,000 | 35,00,000 | 35,00,000 | 35,00,000 |
| CII For FY 2007-08 | 129 | NA | 129 | NA |
| CII For FY 2024-25 | 363 | NA | 363 | NA |
| Indexed Cost of Acquisition | 98,48,837 [35,00,000×363/129] | NA | 98,48,837 [35,00,000×363/129] | NA |
| Capital Gains | 21,51,163 | 85,00,000 | 21,51,163 | 85,00,000 |
| Less: Exemption u/s 54 | 20,00,000 | 20,00,000 | 20,00,000 | 20,00,000 |
| Net Capital Gain | 1,51,163 | 65,00,000 | 65,00,000 | |
| Capital gains for Tax Computation (A) | 1,51,163 | 65,00,000 | 1,51,163 | 65,00,000 |
| Rate applicable (B) | 20% | 12.50% | 20% | 12.50% |
| Tax on Capital Gains [A×B] | 30,233 | 8,12,500 | 30,233 | 8,12,500 |
| = 30,233 (Lower of Option I & II) | ||||
| Remarks | As the flat is sold before 23rd July 2024, Tax at 20% with indexation is applicable. | Section 112 gives relief to resident Individuals & HUF on any excess tax payable under the new regime, i.e. the excess of Rs 7,82,267/- (8,12,500 − 30,233) shall be ignored. Thus on Capital gains of Rs 65,00,000, tax payable shall be Rs. 30,233/- | As the flat is acquired and sold after 23rd July 2024, the New Capital Gains regime of 12.5% without indexation is applicable. | |
Continuing the above example, assume Mr. D has income from other sources of Rs 5,00,000. Total Tax liability computation in the above scenarios is below:
| Particulars | Scenario 1 | Scenario 2 | Scenario 3 |
|---|---|---|---|
| Capital Gains | 1,51,163 | 65,00,000 | 65,00,000 |
| Income from other sources | 5,00,000 | 5,00,000 | 5,00,000 |
| Total Income | 6,51,163 | 70,00,000 | 70,00,000 |
| Tax on LTCG (As computed above) | 30,233 | 30,233 | 8,12,500 |
| Tax on income from Other Sources | 10,000 [After exhausting the basic exemption of Rs. 3 lakhs, the balance 2 lakhs is taxed at 5%] | 10,000 [After exhausting the basic exemption of Rs. 3 lakhs, the balance 2 lakhs is taxed at 5%] | 5,000 [After exhausting the basic exemption of 4 lakhs, the balance 1 lakh is taxed at 5%] * |
| 40,233 | 40,233 | 8,17,500 | |
| Less: Rebate u/s 87A | 25,000 | NA | NA |
| 15,233 | 40,233 | 8,17,500 | |
| Surcharge @10% | NA | 4,023 | 81,750 |
| 15,233 | 44,256 | 8,99,250 | |
| Health and Education Cess @ 4% | 609 | 1,770 | 35,970 |
| Total Tax Payable | 15,842 | 46,026 | 9,35,220 |
* It has been assumed that the budget 2025 rates shall prevail from FY2025-26 and onwards in Scenario 3.
Analysis
The comparative scenarios presented above bring into sharp focus the nuanced effect of the Finance (No. 2) Act, 2024. When Mr. D sells his flat before 23rd July 2024, the availability of indexation drastically reduces his capital gains, qualifying him for the rebate under section 87A due to lower total income. However, scenarios 2 and 3 demonstrate the reality of the post-amendment. Despite identical sale consideration and acquisition cost, the unavailability of indexation post-July 2024 inflates the reported capital gains, raising the total income significantly. This not only results in income surpassing the rebate threshold of Rs 7,00,000/- (or Rs 12,00,000 from FY2025-26 onwards) but also pushes the assessee to the surcharge territory.
What should be the ideal Reinvestment?
Whether it is investment under Sections 54, 54EC, or 54F, the maximum amount eligible for exemption remains unchanged from what it was before the Finance (No. 2) Act, 2024, amendments on properties acquired before 23rd July 2024. In other words, the reinvestment amount required to claim the exemption shall remain the same as before the amendment. The proviso in Section 112(1)(a) ensures that any excess tax payable, arising due to the withdrawal of indexation benefits, will be ignored, but only to the extent that the reinvestment complies with these pre-amendment limits. This means taxpayers can continue to plan their capital gains reinvestment based on erstwhile provisions without worrying about additional tax burdens triggered by the new computation rules.
Loss of Losses
One of the most understated implications of this amendment is the erosion of capital losses that previously arose due to indexation. Under the old regime, an inflated indexed cost could turn even a high-value transfer into a long-term capital loss, eligible for carry-forward and set-off. The new regime eliminates this possibility altogether.
For instance, in the above example, assume the purchase cost of the old flat was Rs. 1 Crore.
Capital Gains calculation is as follows:
| Particulars | Transfer made | ||
|---|---|---|---|
| Before 23rd July 2024 | On or After 23rd July 2024 | ||
| Sale Consideration | 1,20,00,000 | 1,20,00,000 | |
| Less: | Cost of Acquisition | — | 1,00,00,000 |
| Indexed Cost of Acquisition | 2,81,39,535 [1,00,00,000×363/129] | — | |
| Capital (Loss)/Gain | (1,61,39,535) | 20,00,000 | |
Observation
As illustrated above, if a property with a purchase price of ₹1 crore is sold for ₹1.2 crore, the indexed cost (₹2.81 crore) under the old regime would have generated a capital loss of over ₹1.6 crore, which is valuable for tax planning over future years. Post-23rd July 2024, this flips into a gain of ₹20 lakh, simply due to the withdrawal of indexation.
Conclusion
While the Finance Act appears to offer some relief through Section 112(1)(a), the core benefit of indexation, i.e., reducing the quantum of capital gains itself, has been fundamentally diluted. The restoration is, in effect, a comparative tax capping mechanism, not a reinstatement of indexation in its original sense.
It may be noted that the provision parallel to section 112 of the Income-tax Act, 1961, in the 2025 Act is section 197, which also provides for the levy of tax on long-term capital gains @12.5% and adjustment of unexhausted basic exemption limit against long-term capital gains in case of resident individuals and HUFs. Further, in respect of long-term capital gains arising on transfer of land and building acquired before 23.7.2024 by resident individuals and HUFs, this section also provides that the excess tax computed by applying 12.5% on long-term capital gains (calculated without indexation of cost of acquisition/improvement) over the tax computed by applying 20% on long-term capital gains (calculated with indexation of cost of acquisition/improvement) has to be ignored.
For practitioners and taxpayers alike, it’s crucial to differentiate between Indexed gains, which impact gross income, and Indexed tax, which impacts only final liability.
As we navigate these transitions, a clear understanding and precise planning will be the key to minimising tax impact under the new regime. Planning must now consider not just rates and exemptions but the interplay between gross income reporting and tax liability computation.