Taxes
The blog discusses the concept of double indexation as a strategy to lower tax liability on long-term capital gains by adjusting the purchase price of investments for inflation. It explains how indexation helps investors pay capital gains tax only on actual gains and highlights the benefits of double indexation, allowing investors to enjoy indexation benefits for two years, even if the investment is held for just over a year.
In the run-up to March 31 (financial year-end), there is an unmistakable rush to figure out investment strategies that allow 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.
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:
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.
Inflation reduces the currency’s value over time, raising the cost of living as everyday goods become more expensive. For example, what ₹10 could buy twenty years ago is worth far less today. Unfortunately, incomes don’t always keep pace, impacting most pensioners and middle-income earners. That is why financial investments should account for inflation. Indexation, a helpful tool, adjusts investments for inflation, reducing tax liability and helping investors secure better returns over time.
To calculate the indexed cost of an investment asset, one must 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.
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.
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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Disclaimer: *Terms and conditions apply. The information provided in this article is generic 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 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.