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Kotak e-Invest
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Ref. No. KLI/22-23/E-BB/492
Indexation adjusts the purchase price of assets for inflation, reducing taxable capital gains and preserving investment value.
Investing is about making informed decisions that optimize returns and minimize tax liabilities. One powerful tool that investors can leverage is indexation, which adjusts the purchase price of an asset for inflation. This adjustment ensures that the actual value of your investment plan is accurately reflected over time, safeguarding investors against the eroding effects of inflation. Let us understand what is indexation, its types, and how to calculate the indexed cost of debt funds.
Indexation is like adjusting the price tag on something to account for inflation. Imagine you bought a shirt in 2021 for ₹100. A few years later, due to inflation, the same shirt might cost ₹120. Indexation helps you understand the real value of your money over time. It considers how much more expensive things have gotten and adjusts things like investments or taxes accordingly. So, even if your investment shows a profit on paper, indexation helps see if that profit has actually kept pace with inflation. This adjustment is particularly beneficial for long-term investments , as it helps preserve the purchasing power of the returns earned over an extended period.
Indexation can be applied in various contexts, primarily within investments and tax calculations. Here are the primary types:
This is commonly used to calculate long-term capital gains on assets like real estate, bonds, and certain types of mutual funds. It adjusts the purchase price based on the inflation rate, reducing taxable gains.
Income indexation is applied to wages, pensions, and other forms of income to maintain their purchasing power over time. Governments and organizations use it to adjust salaries and benefits in line with inflation.
They are sometimes used to adjust the cost bases for various expenses in business and accounting to reflect inflation-adjusted values.
An Indexation Chart, often called the Cost Inflation Index (CII) chart, is a table published annually by the tax authorities. It provides the inflation adjustment factors for each financial year. The chart is crucial for calculating the indexed cost of acquisition for assets, which is then used to determine the capital gains for tax purposes. Using an indexation chart:
Indexed Cost= (CII in the Year of Purchase/CII in the Year of Sale) × Original Purchase Price
Calculating the indexed cost involves adjusting the original purchase price of an asset using the CII values. Here are the easy steps:
Let’s say you purchased units of a debt fund on April 1st, 2020 (FY 2020-21) for ₹10,000. You sold those units on March 31st, 2024 (FY 2023-24). Let us calculate the indexed cost:
CII Values:
Calculation:
Indexed Cost= (CII in the Year of Purchase/CII in the Year of Sale) × Original Purchase Price
Indexed Cost = (₹10,000 * 363) / 280 = ₹12,964.29 (approximately)
If you are wondering what indexation benefits are, then take a look at these benefits they offer to investors, particularly those with long-term holdings:
By adjusting for inflation, indexation reduces the taxable capital gains, leading to lower tax liabilities.
It ensures that the actual value of investments is maintained over time, protecting against inflation.
The indexation benefits are more pronounced for long-term investments, encouraging investors to hold assets longer.
Using a standardized indexation chart simplifies calculating adjusted costs and capital gains.
As we know, indexation adjusts the cost price of the investment for inflation, reducing your taxable gains. Here are some key strategies to maximize the benefits of indexation in India:
Holding investments for extended periods enhances indexation benefits as the inflation adjustment becomes more significant.
Including assets eligible for indexation, like debt funds and real estate, in the portfolio can provide tax advantages.
Strategic timing of asset sales to coincide with higher inflation periods can maximize indexation benefits.
The government publishes the CII annually. Use this index to calculate the indexed acquisition cost for your debt funds.
Debt fund investments must be held for over three years to qualify for indexation benefits. Only long-term capital gains arising from the sale of debt fund units after this holding period are eligible for indexation. If the units are sold within three years, the gains are considered short-term and taxed at the investor’s applicable income tax slab rate without any indexation benefit.
The indexed acquisition cost is calculated using the Cost Inflation Index (CII) values provided by the government for each financial year.
Indexation is a valuable financial tool that helps investors manage inflation’s impact on their long-term investments. Adjusting the purchase price of assets provides significant tax advantages and preserves the actual value of returns. Understanding and utilizing indexation can lead to better investment decisions and enhanced financial outcomes.
1
Indexation advantage is not allowed on short-term capital gains and for certain assets like equity mutual funds held for less than a year.
2
Indexation cannot be negative; it constantly adjusts the cost of acquisition upwards based on inflation, reducing taxable gains.
3
Investors can find the Cost Inflation Index (CII) chart on the official website of the Income Tax Department of India or through financial news portals.
4
Capital gains with indexation on mutual funds are calculated by adjusting the purchase price using the CII, which reduces the taxable amount of long-term gains.
5
Indexed mutual funds replicate a specific index and have lower management fees, while actively managed funds are managed by portfolio managers aiming to outperform the market.
6
The indexation method involves adjusting the purchase price of an asset using the CII, accounting for inflation, and reducing the taxable capital gains.
7
Indexation benefits long-term investments by reducing the taxable capital gains through inflation adjustment, potentially lowering the overall tax liability.
Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.
Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors
In this policy, the investment risk in the investment portfolio is borne by the policyholder.
Kotak e-Invest
Features
Ref. No. KLI/22-23/E-BB/521
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The content has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Further customer is the advised to go through the sales brochure before conducting any sale. Above illustrations are only for understanding, it is not directly or indirectly related to the performance of any product or plans of Kotak Life.
