The cost inflation index is a means to measure inflation in an economy, which is ultimately used in measuring the net long-term capital gains with respect to sale of assets. Due to inflation, the price of any asset keeps on increasing over a period of time, which leads to a large discrepancy between the cost and the sale price of the asset. Larger is the difference between the cost and sale price, larger is the capital gains to the owner of the asset. These capital gains earned are liable to taxation. So, larger quantum that a person earns by the sale of a particular asset, the higher amount of taxes he/she is supposed to pay for it. But the tax paid by the person could be minimised by indexing the sale price of the asset with inflation. When an asset-owner uses the cost inflation index to standardise the present value of an asset, he/she minimises the amount of taxes that he/she pays over it.
Firstly, the cost of acquisition of the asset has to be multiplied with the cost of inflation of the year in which it was transferred. The figure has to be divided by the cost inflation index for the year in which it was acquired. If the asset has been purchased before 1981, the CII must be taken into consideration for 1981. In situations where the asset owner has made improvement in the asset, then the CII has to be adjusted by multiplying the value by CII of the year in which the improvement was made. Here is a CII chart to provide you with information regarding CII for FY 2018-2019.
How can Cost Inflation Index reduce Tax?
Indexation of Cost Inflation Index cannot give any short-term gains or losses. The benefit from CII is also not applicable on NRIs. Indexation can be made available to you if you meet the following criteria