Navigating Indexation Benefits after the Finance (No.2) Act, 2024

Introduction

Indexation is a measure of inflation that finds application under the Income-tax Act, 1961 (hereinafter referred to as \"the Act\") while computing long-term capital gains on sale of assets. Indexation harmonizes the purchase price with inflation when calculating long-term capital gains arising from the sale of assets, resulting in a more accurate assessment of gains and a consequent reduction in tax liability. Index is notified by the Central Government every year, having regard to 75% of average rise in the consumer price index (CPI) for the immediately preceding previous year. The Cost Inflation Index was first notified for the financial year 1981-82 in India, and the cost inflation index for the year 2024-25 is 363.

How Indexed cost of acquisition is computed

Since \"cost of acquisition\" is historical, the concept of indexed cost allows the taxpayer to factor in the impact of inflation on cost. Consequently, a lower amount of capital gains gets to be taxed than if historical cost had been considered. The indexation for the cost of acquisition is calculated in accordance with the following process:

• Cost of acquisition of the asset has to be multiplied with the cost of inflation Index of the year in which it was transferred.
• That figure has to be divided by the cost inflation index for the year in which the asset was acquired.
• If the asset was purchased before 2001, the cost inflation index of the year 2001-02 must be taken into consideration and the fair market value as on 1st April 2001 needs to be considered.
• If improvement of the asset has been made, then one needs to adjust the cost inflation index of the improvement made divided by the CII for the year in which improvement has been made.

Formula for computing indexed cost is = (Index for the year of sale / Index in the year of acquisition) × cost.

Benefits of Indexation

Prior to the amendment by the Finance (No.2) Act, 2024, long term capital gain tax u/s 112 of the Act was 20% in case of indexation benefit. Thus, indexation helps in adjusting the purchasing price of the asset with current market prices, though it is not applicable on short term capital gain or losses.

Impact due to amendment in Budget presented 2024

The Finance (No. 2) Bill, 2024 presented by Finance Minister Nirmala Sitharaman proposed eliminating the indexation benefit. To reduce the impact, the long-term capital gains (LTCG) tax rate was decreased from 20% to 12.50% w.e.f. 23.07.2024, but without the benefit of indexation. This change significantly impacted real estate investors, as tax liabilities could have escalated many times for properties acquired post-2010.

Critical Review of the Relief provided while passing the Finance Bill (No.2), 2024 in Lok Sabha

The Lok Sabha passed the Finance (No. 2) Bill, 2024 on August 7th and amended the earlier proposed long-term capital gains tax provision on immovable properties, giving taxpayers an option to choose the lower of the following:

• a) 12.5% Long-Term Capital Gains (LTCG) tax rate without indexation, or
• b) 20% rate with indexation, for properties purchased before July 23, 2024.

This grandfathering clause ensures that properties bought before July 23, 2024, are not adversely affected by the new rules.

Whether Indexation relief is beneficial or not

The choice between using the indexation benefit or opting for the new 12.5% LTCG tax rate depends on the specific financial situation, holding period, quantum of appreciation, and purchase price of the asset. Concessional rate of tax with no indexation benefit is favourable in cases where sale consideration is high. Eligible resident individuals and Hindu Undivided Families (HUF) can avail this option under the second proviso to section 112(1)(a) for properties acquired before July 23, 2024.