The benefit of indexation while computing capital gains is provided under Section 48 of the Income Tax Act, 1961. This provision allows for the adjustment of the cost of acquisition and improvement of a long-term capital asset to account for inflation, using the Cost Inflation Index (CII).

Section 48 – Computation of Capital Gains:

“The income chargeable under the head ‘Capital Gains’ shall be the difference between the full value of consideration received or accruing from the transfer of a capital asset and the cost of acquisition of the asset and the cost of any improvement to the asset, as increased by the Cost Inflation Index (CII), in the case of a long-term capital asset.”

Benefit of Indexation:

• Reduces Taxable Capital Gains: By inflating the cost of your asset, indexation reduces the overall gain on which tax is calculated.

• More Beneficial for Long-term Assets: Since assets held for a longer time usually appreciate significantly, indexation can lead to a lower tax liability when you eventually sell the asset.

When is Indexation Allowed?

• Only for Long-Term Capital Assets: Indexation is applicable only to long-term assets (held for more than 36 months).

• For Both Purchase Cost and Improvement Costs: You can adjust both the purchase cost and any improvement costs using the CII.

• If Indexation is Opted, It Must Be Applied to Both Purchase and Improvement Costs: Once you choose to apply indexation, you must apply it to both the original purchase price and any improvement made to the asset.