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Plan your tax

Cost Inflation Index numbers help in calculating the exact long-term capital gains, writes Arnav Pandya.

india Updated: Aug 30, 2007 00:14 IST

The new Cost Inflation Index (CII) for the year 2007-08 has been announced and investors can use this in planning as well as understanding the tax liability that they will face in the coming days. This is necessary because it is an important part of the entire long-term capital gains calculation.

Cost inflation index
In the case of long-term capital gains, there is a provision in the Income Tax Act whereby the individual can use the Cost Inflation Index to raise the cost price of the asset. This will result in a lower tax burden for the individual when the capital gains are calculated. The long time period of holding is sought to be compensated through the rise in the cost so that the inflation impact is smoothened out. The Cost Inflation Index is announced each year by the tax authorities and this is to be used in the capital gains calculation.

Not useful
Now, there has to be a distinction between the areas in which the CII will be financially beneficial and where it will not be. First, one has to check a couple of areas where this would not provide any benefit. One such area is while calculating capital gains in shares when these are sold on the stock exchange and the Securities Transaction Tax is paid on it. An investor can use the CII to calculate the gains that have been made but this has little value due to the fact that the amount is tax-free. So, there is not much of an impact in terms of savings of tax.

The second area is while calculating the gains on the debt-oriented funds or equities where the zero rate is not applicable. Here, an individual has a choice of using the 20 per cent rate with the benefit of indexation or 10 per cent rate without the benefit of indexation. In the toss up while the figure of CII would be used for the workings, there is a good possibility that in the final analysis the 10 per cent rate is selected and due to this the CII figure would not make an impact in the overall calculation.

Calculation
With the rate for 2007-08 announced, here is a short example to see how the rate works out in real life. Assume that a house is purchased in January 1999 and is sold in August 2007. The purchase price of the house is Rs 12 lakh while the sale price is Rs 29 lakh. In such a situation, the cost price of the house in indexed terms has to be calculated.

The CII number in the year 1998-99 was 351 and the figure for the financial year 2007-08 is 551. Thus, the cost of the house will become Rs 18,83,761 resulting in a long-term capital gain of Rs 10,16,239.

This is the figure on which the 20 per cent tax will have to be paid or this amount can be invested in specified areas in order to avoid the tax.

(The writer is a Certified Financial Planner)