Double Indexation to Lower Taxes
23 August, 2023
In the run-up to March 31 (financial year-end), there is an unmistakable rush to figure out investment strategies that allow for maximum savings on one’s tax liability beyond the ₹1,50,000 deduction available under Section 80C of the Income Tax Act. This article will discuss the benefits of indexation, which helps offset the impact of inflation on a long-term asset’s purchase price so that one is only liable to pay capital gain tax on actual gains. The article also sheds light on double indexation. It offers investors indexation benefits for two years even if the investment holding is for less than that period.
What is indexation?
To understand indexation and its benefits, one will need to understand capital gains tax, which is the tax payable on the profit an investor makes upon the sale of an investment. The sale of an asset held for over 365 days or one year will attract long-term capital gain tax. There are two ways to calculate the tax liability on long-term capital gains:
With indexation (charged at 20% plus surcharge)
Without indexation (charged at 10% plus surcharge).
Indexation means the purchase value of an investment adjusted for inflation. The significance of this can be best understood when one fully appreciates the impact of inflation on our lives.
In essence, inflation hurts the value of currency over time. As one must often have noticed, there is a difference between goods one could have bought with ₹10 twenty years ago compared to today, when even a decent bar of chocolate would cost more than that. Effectively, inflation pushes up one’s cost of living.
Unfortunately, our incomes (including salary raises occasionally) do not rise in keeping with inflation, making it particularly difficult for pensioners and those belonging to low or middle-income sections.
Thus, one’s financial investments should be made keeping this in mind. One should account for inflation when making investment choices. Indexation can be a priceless tool for investors since it allows one to factor in the value of their investment after adjusting for inflation. It brings down their overall tax liability and helps them clock in a decent investment return.
To calculate the indexed cost of an investment asset, one will need to refer to the Cost Inflation Index (CII) figures that the government releases every year.
Notified by the Central Board of Direct Taxes (CBDT), the CII figures for a given financial year help calculate the indexed or inflation-adjusted asset price.
Benefits of indexation
Indexation raises the purchase price of an investment, thereby bringing down the taxable capital gains one makes upon the sale of a long-term investment. It also brings down the tax liability. Lower tax liability converts to more money freed up.
One can avail of indexation benefits on long-term capital gains made from various financial investment instruments, including but not limited to real estate, debt mutual funds and gold.
How double indexation works
Once the concept of indexation is clear, double indexation is easy to understand. Double indexation benefit is merely the enjoyment of the indexation benefit for two years on an investment held for just a little over a year, which could be as little as a day.
Indexation benefits savvy investors and those with a considerably lower appetite for risk.You can invest in a wide range of funds with complete control over your investments through HDFC Bank
Read More About Double Taxation, And How To Avoid It?
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*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice from before you take any/refrain from any action. Tax benefits are subject to changes in tax laws. Please contact your tax consultant for an exact calculation of your tax liabilities.
