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It a fact that the purchasing power of money reduces over time. An Rs. 2000 note today will fetch lower value a year later and further lower a decade later. In normal parlance, this is referred to as inflation, which reflects the increase in prices of commodities and services across different periods.
It a fact that the purchasing power of money reduces over time. An Rs. 2000 note today will fetch lower value a year later and further lower a decade later. In normal parlance, this is referred to as inflation, which reflects the increase in prices of commodities and services across different periods. Income tax laws also conceptualise this reality through the provisions of indexation benefit while calculating the capital gains on investments.
How are Capital Gains Calculated?
When it comes to calculating capital gains on mutual fund investments, the investor needs two primary inputs – the invested amount and the redemption value. The difference between these two figures represents the actual returns generated by the investors. Such returns are classified into Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) depending upon the type of mutual fund scheme and the holding period.
For equity-oriented funds, the specified period of holding for categorisation of capital gains as LTCG is 12 months. For other funds like debt funds, gold funds, etc., such a period is 36 months. As such, the gains from the mutual fund units held for less than 12/ 36 months in equity funds/ other funds; respectively, the gains will be classified as STCG. For units with a longer holding period, the gains will be classified as LTCG. The tax rates also differ on different types of capital gains.
Indexation benefit
Indexation refers to adjusting the cost of a capital asset, which is equivalent to the invested amount, to the prevailing inflation over the years. is notified by the Govt. every year to ensure uniformity in this regard. The CII Cost Inflation Index (CII) notified for different years.
Benefit of Indexation
With CII value being notified by the Govt. based on inflation figures over the years, the indexation benefit adjusts the value of an investment to calculate Capital Gains and effectively reduces the overall tax incidence on such returns by considering the impact of inflation over the years.
Calculation of Indexation
The indexed cost of investment is calculated as below:
Indexed Cost of Investment = Invested Amount X CII for redemption year/ CII for the year of investment
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