September 2013 ~ Vardhman Insure Finvest Blog Powered By Wealth Smart Planners

Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

A string of numbers like 939, 852, 785, 711, can you guess what these are? These numbers have potency to save a lot of money particularly if you are investing in Mutual Funds or Real Estate. And to answer the question- these numbers are value of Cost Inflation Index (CII) from year 2013-14 to year 2010-11. As the term suggest it refers to the cost of asset, which faces inflation. Let’s try to understand the concept and application in detail.

Cost Inflation Index – The Concept

There are 2 terms to calculate gain on any investment. One is the simple (nominal) return and second is called the real returns. The difference between the two is inflation. For eg a house purchased in 2005 for Rs 4 Cr in Mumbai and sold for 5 Cr in 2013 the gain is Rs 1Cr. Or simply:

Nominal Gain = Selling Price of Asset – Purchase Price of Asset

But is the concept right? Was Rs 4 Cr in 2005 a smaller amount? It is not equivalent to Rs 4 Cr of present times as the value of money has eroded due to country’s inflation. So would it be right by the Income Tax department to charge tax on entire gain? Instead they should be charging the tax on Real Return, which are returns minus the inflation.

Real Gain = Selling Price of Asset – Inflation Adjusted Purchase Price of Asset

So how do you calculate the Inflation Adjusted Purchase Price? If let on investor, each person will have his own view in inflation, hence the CBDT (Central Board of Direct Taxes) comes out with a unique number, which is used for calculating indexed cost. For the year 2013-14 the number is 939 vis a vis 852 for year 2012-13. This means CBDT thinks that in this year inflation eroded value of assets by 10.2% ((939-852)/852 multiply by 100). The table below shows the indexation figures for 1981 when the base was taken as 100.

Cost Inflation Index table Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

Cost Inflation Index (CII) 2013-14 939

Hence CBDT standardizes the calculation for purchases price of an investment. They started giving this number for year 1982-83. For all purchases before 1981, the factor used is the base factor which is 100. (but if its real estate you have to bring some documents which provides rates of property in that area in 1980 – registries that were done in that period)

CII – The Implication

In case of long term capital gains an investor can reduce his tax payment by using the indexation benefit. The rules are a bit different for real estate and securities:

1) For investments in Property: The Long Term Capital Gain (LTCG) is calculated when property is sold after 3 years otherwise it is a Short Term Capital Gain.

Tax payment= 20% of gains after taking indexed purchase cost

(It is mandatory to take the indexed cost as purchase price)

2) For investments in Securities: The Long Term Capital Gain (LTCG) is calculated when investments is sold after 1 years otherwise it is a Short Term Capital Gain.

Without Indexation Tax Payment = 10% of Gain

With Indexation Tax payment= 20% of gains after taking indexed purchase cost

Calculation for above example:

Indexed purchase price = Purchase cost multiply Index Factor

Indexed purchase price = (4 Cr * Index Factor of 2013)/Index Factor of 2005-06

Indexed purchase price= (4 Cr * 939)/497

Indexed purchase price= 7.56 Cr

Since purchase price is more than the Selling price, the investor is making a loss hence no tax is payable.

Applicability

The cost inflation index can be used for calculating long term capital gains (LTCG) for investments in securities and real estate. Since LTCG is nil for investments in Equities, hence it has no relevance for calculating LTCG for investments in shares and equity mutual funds. But it is useful to calculate LTCG in debt oriented mutual funds (especially Bond funds and Fixed Maturity Plans).

Ground rule:

In case of Debt Mutual Funds LTCG can be claimed only if the holding period is more than 1 year.
In case of property LTCG can only be claimed if the holding period is more than 3 years.

It cannot be used to:

Calculate STCG in case of property if sold in less than 3 years of holding period.
Calculate LTCG on equity investments as they are tax free as per current rules.

An example above showing how this is used in property transaction. How this can be used in debt funds. The concept is widely used in FMPs from mutual funds. The reason you of FMP issues of 13 months or 25 months in March month. The idea is to get a double indexation or triple indexation benefit. So if a 13 month FMP allotment date is on 25 March 2012 and maturing on 26 April 2013, it passes through two 1 April dates hence it can claim a double indexation benefit and will use indexation figure of 2011-12 and 2013-14 for calculating the LTCG.

So if one invests Rs 7.5 Lakhs in a 367 day FMP in March 2012, and gets maturity in April 2013 the working under Double Indexation Benefit will be as mentioned below. Also a comparison with the fixed deposit of similar tenure has been tabulated:

Calculation with Indexation Benefit
	FMP	Fixed Deposit
Amount of Investment	7,50,000	7,50,000
Annualised Yield	10.35%	10.35%
Tenure	367 Days	367 Days
Maturity Amount	8,28,077	8,28,077
Gain	78,077	78,077
Indexed Cost	8,26,585	NA
Indexation Gain/Loss	(76585.00)	NA
Income Tax	Nil	Gain will be added to income.

So indexation can be used to save a good amount of tax payment especially if a person comes in higher tax brackets. This is the reason Fixed Maturity Plans (FMPs) and bond funds have seen a rise in issue and subscription. This benefit can and should be taken by investing towards the end of a financial year, if the investor has surplus funds, because the capital gains virtually becomes tax free due to the double indexation benefit. A major number of investors are unaware about this benefit.

What is rupee-cost averaging? (SIP)

Rupee Cost Averaging (SIP)

What is rupee-cost averaging?

Investors generally tend to speculate on the right time to invest. But it is a known fact that no one can predict where the market is going to move-upwards or downwards. Rupee-cost averaging has been the answer to such a scenario.

With rupee-cost averaging, an investor invests a specific amount at regular intervals irrespective of the investment’s share (unit) price. By investing regularly, the investor takes advantage of market dips without worrying about when they’ll happen. Their money buys more units when the price is low and fewer when the price is high, which can mean a lower average cost per unit over a period of time.

The key factor of rupee-cost averaging is commitment. How frequently an investor invests (weekly, fortnightly, monthly or quarterly) is not that much relevant in long term? What matters is to stick to his investment mode in tougher times like we experiencing now.

How does Rupee Cost Averaging works when prices are moving upwards and downwards?

Below are the two examples to see what an investor’s average price per unit would be when prices are rising and when prices are falling.

Unit price is rising scenario. Rs.1000 is invested in a mutual fund on the first of each month. The investor in this example would methodically acquire 244.53 units at an average cost of Rs.24.54 each

Rupee-Cost Averaging (unit price rising scenario)

Month	Amount Invested	Unit Price	No. of units purchased
15-Jan	Rs 1000	20	50
15-Feb	Rs 1000	22	45.46
15-Mar	Rs 1000	23	43.48
15-Apr	Rs 1000	25	40
15-May	Rs 1000	30	33.33
15-Jun	Rs 1000	31	32.26
	Total: Rs 6000	Avg Cost:Rs 24.54	Total:Rs 244.53

Unit price falling scenario. Rs.1000 is invested in a mutual fund on the first of each month. The investor in this scenario would have bought 204.87 units at an average cost per unit of Rs.24.91.

By comparing, someone who invested the entire Rs.6000 in January at Rs.35 per unit would have owned only 171.43 units, and the investment would have been worth only Rs.4285.75 at the end of the period.

Rupee-Cost Averaging (unit price falling scenario)

Month	Amount Invested	Unit Price	No. of units purchased
15-Jan	Rs 1000	35	28.57
15-Feb	Rs 1000	33	30.30
15-Mar	Rs 1000	30	33.33
15-Apr	Rs 1000	28	35.71
15-May	Rs 1000	27	37.03
15-Jun	Rs 1000	25	40
	Total: Rs 6000	Avg Cost: Rs 24.91	Total: Rs 204.87

Advantages of Rupee Cost Averaging (SIP)

Averaging reduces the risk factor associated with lump sum investing. For example we all are familiar with the scenario where investors who invested their money at one go when market was at its peak in the year 2007-2008 what their plight was when market crashed drastically in the year 2008. With RCA, investors get a buying opportunity when the NAV falls as he will be able to accumulate more units of the mutual fund scheme.

RCA frees investors from the onus of monitoring stock positions on a daily basis which would be the scenario in case of lump sum investment or VCA. It serves as a cushion against the downward trend of the market.

Investor no longer needs to look at dates, markets or anything. Investor no longer needs to monitor external factors like economy condition, interest rates, inflation etc.

It is a disciplined approach towards investing regularly in mutual funds. -

Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

What is rupee-cost averaging? (SIP)

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Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

Cost Inflation Index – The Concept

CII – The Implication

What is rupee-cost averaging? (SIP)

What is rupee-cost averaging?

How does Rupee Cost Averaging works when prices are moving upwards and downwards?

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Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

What is rupee-cost averaging? (SIP)

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About Us

Contact Form

Pages

Total Pageviews

Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

Cost Inflation Index (CII) How it impacts Capital Gain Tax on Real Estate & Mutual Funds

Cost Inflation Index – The Concept

CII – The Implication

What is rupee-cost averaging? (SIP)

What is rupee-cost averaging?

How does Rupee Cost Averaging works when prices are moving upwards and downwards?

Archive Blog

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