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All About Tax Indexation

The tax to be paid is applicable only on real gains

While calculating tax for debt funds, what is meant by tax with indexation and tax without indexation? How can I find out whether I need to follow the indexation or without indexation rate? Is that something to be consulted with the fund house? Which one is more beneficial?

-    Raju M.

Indexation is a benefit that allows you to remove the impact of inflation on your investments. It means that you do not have to pay tax on gains that have been eaten up by inflation. So this concept ensures that tax is paid only on the real gains.

For the purpose of calculating the actual gains, the government constructs an index called the cost of inflation index (CII). This index has its base year as 1981-82 and the value for that year is 100. Subsequently for each financial year, the value of the index is declared. To determine the gains component on which tax has to be paid, the ratio of the inflation index at the time of sale of the instrument to its value at the time of purchase is taken. This is multiplied by the cost of acquisition of the asset. This gives the indexed cost of acquisition. In order to determine the capital gains after accounting for inflation, the indexed cost of acquisition is subtracted from the sale consideration.

Based on this concept, investors have the option to pay long term capital gain tax at the rate of 20 per cent with indexation or 10 per cent without indexation, whichever is lower. You need not consult the fund house for this.

Coming to your last question, no one option can be said to be beneficial for all. It will vary from case to case. So, one has the option to pay the lower tax, whichever is more beneficial to an investor.

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