Indexation

Source- This post on the Indexation has been created based on the article “What is indexation in calculating LTCG tax? Does the removal of indexation benefit in the Budget mean you will pay more tax?” published in “Indian Express” on 29 July 2024.

The withdrawal of the indexation benefit in the long-term capital gains (LTCG) tax regime is one of the most contentious decisions announced.

About Indexation:

1. Indexation is the process of adjusting the original purchase price of an asset or investment to account for inflation.

2. Purpose: It helps to neutralize the impact of inflation, ensuring that the value of money remains consistent over time.

3. How Indexation Works:

i) Over time, inflation reduces the purchasing power of money. When an asset is sold or an investment is redeemed, inflation can affect the returns.

ii) Indexation calculates the cost of acquisition by factoring in inflation over the holding period. This adjusted cost is called the indexed cost of acquisition.

iii) Returns calculated using the indexed cost of acquisition are considered more realistic compared to absolute gains based on the original purchase price.

4. Benefits of Indexation:

i) Indexation helps in preventing the erosion of investment returns by reducing the amount of taxes paid on long-term investments.

ii) It is applicable to long-term investments, such as debt funds and other asset classes, ensuring the purchase price of investments is adjusted for inflation.

UPSC Syllabus: Indian Economy