Indexation Meaning and Its Role in Taxation

The indexation meaning is simple, it lets you adjust the cost of your investment based on inflation. This reduces your taxable gains when you sell a long-term asset. It was especially useful in areas like property, gold and mutual funds. But recent Budgets have changed where you can use this benefit.

Read on to understand what is indexation, how it works, how to calculate it, which assets still qualify and what the latest tax updates mean for you. 

Indexation in Mutual Funds

The indexation meaning is about adjusting the value of your investment as per inflation. It helps you understand the real profit when you sell an asset after a few years. In short, it compares your investment cost with current prices to show true returns.
Let’s understand this with an example. Say you made a lump sum investment in a debt mutual fund scheme for ₹2 lakh. After 3 years, you sell it for ₹2.5 lakh, earning a total profit of ₹50,000. This earned profit is subject to taxation according to tax norms. 

However, the current price of the same mutual fund scheme for the same number of units is ₹2.1 lakh due to inflation. As per the current rate, your total taxable profit is ₹40,000. Thus, you can save tax on the difference of ₹10,000 between the indexed and unindexed value of gains. 

Why Indexation Matters in Capital Gains Tax?

To have a better understanding of Indexation, here’s a simplified look at how capital gains are taxed based on how long you hold an asset:

• Short-term capital gains (STCG): Applied when you sell assets before the minimum holding period, generally within 12 months for listed shares and equity mutual funds. From 23 July 2024, STCG on these is taxed at 20%.
• Long-term capital gains (LTCG): Applies to assets held longer, typically over 12 months for equity and over 24 months for others. From 23 July 2024, LTCG across all asset classes is taxed at 12.5%, without indexation benefits. However, equity gains get an ₹1.25 lakh annual exemption.

There is a grandfathering rule: If you bought property or other assets before 23 July 2024, you can still choose to pay 20% with indexation instead of the flat 12.5%, if that results in lower tax.

Calculation of Indexation

To adjust your investment cost for inflation, the government provides the Cost Inflation Index (CII). It’s released every year by the Income Tax Department and helps you work out how much your investment’s original cost would be worth today.

Here’s how the calculation works:

Let’s suppose Aditi invested in 1,000 units of a debt mutual fund at ₹22 per unit in the financial year 2015-16. She sells them for ₹34 per unit in 2024-25. Since she held them for more than 3 years, this qualifies for indexation.

• Total Purchase Cost: ₹22 × 1,000 = ₹22,000
• Total Selling Value: ₹34 × 1,000 = ₹34,000
• CII for 2015-16: 254
• CII for 2024-25: 363

Now, adjusting the purchase cost for inflation using the CII:

• Inflation-adjusted cost = ₹22 × (363 ÷ 254) = ₹31.44 per unit
• Total Adjusted Cost = ₹31.44 × 1,000 = ₹31,440

So, the long-term capital gain is ₹34,000 – ₹31,440 = ₹2,560

So, instead of paying tax on the entire ₹12,000 profit, Aditi will pay tax only on ₹2,560. 

What is the Cost Inflation Index (CII)?

Cost of acquisition means the price at which you started an investment or purchased a property, including all charges. To get the CII, you can use the following table: 

Financial year	Cost Inflation Index
2001-02	100
2002-03	105
2003-04	109
2004-05	113
2005-06	117
2006-07	122
2007-08	129
2008-09	137
2009-10	148
2010-11	167
2011-12	184
2012-13	200
2013-14	220
2014-15	240
2015-16	254
2016-17	264
2017-18	272
2018-19	280
2019-20	289
2020-21	301
2021-22	317
2022-23	331
2023-24	348
2024-25	363
2025-26	376

If you have all the information available, simply use this formula: 

Indexation = Cost of acquisition x (CII of the base year / CII of the sale year)

Since inflation is always rising, your indexed cost of acquisition (ICoA) will be higher than the original investment amount. Therefore, when you subtract this ICoA from your long-term capital gain, the subtracted amount is the profit you do not have to pay tax on.

Also Read: What is Advance Tax?

Indexation Benefits

This system was beneficial in lowering the tax outgo on profits from capital gains. Here’s how it helped:

• To adjust your asset value according to the inflation in the economy during your year of investment
• To encourage investors to opt for long-term investment, thanks to savings on taxes 
• To ensure maximum benefit due to long-term capital gain 

Assets Eligible for Indexation Benefits

You can still get indexation benefits on some older investments. But, this is only applicable if they were made before specific dates:

• Real estate: If you bought it before 23 July 2024
• Debt mutual funds: If you invested before 1 April 2023
• Gold and other assets: Only if purchased before their respective cut-off dates
• Unlisted shares: If held long enough and meet the tax rules

If your investments were made after these dates, indexation won’t apply.

Revision in Indexation Benefits

Budget 2023 and Budget 2024 brought major changes. Here’s a quick summary:

• Debt Mutual Funds: No indexation on funds bought after 1 April 2023. Gains taxed as per income slab.
• Real Estate: For property bought after 23 July 2024, indexation no longer applies. You pay flat 12.5% LTCG tax instead.
• Other Assets: Indexation on gold, ULIPs and more have been withdrawn gradually.

Today, indexation benefits are no longer valid on investments in property, mutual funds, gold and more. However, you now pay lower long-term capital gains tax, which helps to adjust the benefit. 

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FAQs on Indexation 

What is an example of indexation?

Here are the steps to understand the process: 

• Assume you invested ₹20,000 between 2014 and 2015 and decided to sell the investment in 2024, where the total earnings come to ₹35,000
• During the investment year, the cost inflation index was 240, which has now risen to 363. Considering this, your index cost of acquisition will be ₹30,250
• Since you calculate capital gain as the difference between the selling price and the indexed cost of acquisition, total capital gain is ₹4,750

As such, you can reduce your tax liability significantly.

What is the 20% indexation benefit?

This means that your total long-term capital gains from debt fund investment are taxable at a 20% rate after indexation. This benefit has now been abolished by the Indian Government. 

What is indexation in the case of property?

When you sell a property, you have to pay tax on the total gains. By indexation, you get the benefit of adjusting your profit against inflation. This lowers your taxable profit and, thus, your total tax. As per the Budget 2024, this benefit is no longer applicable. However, if you have purchased a property before July 23, 2024, you can choose between paying 20% long-term capital gains tax with indexation benefits or a 12.5% tax.