COST OF IMPROVEMENT IN DIFFERENT SITUATION – Sailesh Bhandari & Associates

The cost of improvement under the Income Tax Act of India is the capital expenditure incurred by an assessee in making any addition or alteration to a capital asset. It also includes any expenditure incurred in protecting or curing the title to the capital asset.

The cost of improvement is important for income tax purposes because it is used to calculate the capital gains tax payable on the sale of a capital asset. Capital gains tax is calculated on the difference between the sale proceeds of the capital asset and its cost of acquisition and improvement.

The cost of improvement is different in different situations, depending on the type of capital asset, the nature of the improvement, and the time when the improvement was made.

Here are some examples of cost of improvement in different situations under the Income Tax Act:

Cost of improvement of a house property under Income Tax Act: This may include the cost of construction, repairs, renovation, and extension of the property.
Cost of improvement of a business asset under Income Tax Act: This may include the cost of purchasing and installing new machinery and equipment, and the cost of making modifications to existing assets.
Cost of improvement of an investment asset under Income Tax Act: This may include the cost of purchasing additional units of an investment asset, and the cost of paying stamp duty and brokerage on such purchases.

It is important to note that the cost of improvement does not include any expenditure which is deductible in computing the income chargeable under the head “Interest on securities”, “Income from house property”, “Profits and gains of business or profession”, or “Income from other sources”.

Here are some examples of expenditure which is not included in the cost of improvement under Income Tax Act:

Interest on loans taken to finance the improvement
Municipal taxes paid on the property
Repairs and maintenance expenses
Insurance premiums

Taxpayers should carefully maintain records of all capital expenditure incurred on their capital assets, so that they can accurately calculate the cost of improvement when they sell the asset.

EXAMPLES

Examples of Cost of Improvement in Different Situations underIncome Tax Act

The Income Tax Act defines “cost of improvement” as all expenditure of a capital nature incurred in making any additions or alterations to a capital asset. It does not include any expenditure which is deductible in computing the income chargeable under the head “Interest on securities,” “Income from house property,” “Profits and gains of business or profession,” or “Income from other sources.”

Here are some examples of cost of improvement in different situations under Income Tax Act:

Construction of a new building under Income Tax Act: This is a clear example of a cost of improvement. The cost of construction of a new building is added to the cost of land to determine the cost of the capital asset.
Renovation of an existing building under Income Tax Act: This is also a cost of improvement. The cost of renovation of an existing building, such as adding a new floor or room, is added to the cost of the building to determine the cost of the capital asset.
Adding a new feature to a building under Income Tax Act: This is also a cost of improvement. For example, the cost of adding a swimming pool or a garage to a house is added to the cost of the house to determine the cost of the capital asset.
Making improvements to land under Income Tax Act: This is also a cost of improvement. For example, the cost of levelling land, filling land, or constructing a road on land is added to the cost of the land to determine the cost of the capital asset.
Making improvements to machinery and equipment under Income Tax Act: This is also a cost of improvement. For example, the cost of overhauling a machine or adding a new attachment to a machine is added to the cost of the machine to determine the cost of the capital asset.

It is important to note that the cost of improvement is not the same as the cost of repairs and maintenance. Repairs and maintenance expenses are deductible from the income of the taxpayer in the year in which they are incurred. However, the cost of improvement is added to the cost of the capital asset and is depreciated or amortized over the useful life of the asset.

Here are some examples of expenses that are not considered to be cost of improvement under Income Tax Act:

Regular repairs and maintenance expenses: For example, the cost of painting a house or repairing a leaky faucet is not considered to be a cost of improvement.
Expenses that are deductible in computing the income chargeable under the head “Interest on securities,” “Income from house property,” “Profits and gains of business or profession,” or “Income from other sources “under Income Tax Act: For example, the cost of interest paid on a loan taken to purchase a capital asset is not considered to be a cost of improvement.
Expenses that are of a revenue nature under Income Tax Act: For example, the cost of advertising a property for sale is not considered to be a cost of improvement.

CASE LAWS

Case 1:CIT v. Kantilal Ranchhoddas (1988) 174 ITR 170 (SC)

In this case, the Supreme Court held that the cost of improvement incurred on a capital asset before it became the property of the assessee can be claimed as a deduction under section 55 of the Income Tax Act, 1961, even if the improvement was made by a previous owner.

Case 2:CIT v. Shree Niwas Cotton Mills Co. Ltd. (1972) 82 ITR 289 (SC)

In this case, the Supreme Court held that the cost of improvement incurred on a capital asset after it became the property of the assessee can be claimed as a deduction under section 55 of the Income Tax Act, 1961, even if the improvement was made for the purpose of increasing the business profits of the assessee.

Case 3:CIT v. Mahalakshmi Sugar Mills Co. Ltd. (1996) 219 ITR 103 (SC)

Case 4:CIT v. Tata Engineering and Locomotive Co. Ltd. (2011) 338 ITR 373 (SC)

Case 5:CIT v. Mahindra & Mahindra Ltd. (2018) 384 ITR 612 (SC)

FAQ QESTION

Q: What is the cost of improvement under the Income Tax Act?

A: The cost of improvement under the Income Tax Act is the capital expenditure incurred by an assessee for making any addition or alteration to a capital asset. It also includes any expenditure incurred in protecting or curing the title.

Q: What are the different types of improvements that may be eligible for cost of improvement deduction under Income Tax Act?

A: Some of the different types of improvements that may be eligible for cost of improvement deduction includeundrIncome Tax Act:

Construction of new buildings or structures
Renovation or extension of existing buildings or structures
Addition of new amenities or facilities to existing buildings or structures
Repair or replacement of damaged or worn-out parts of buildings or structures
Improvement of land, such as leveling, grading, and irrigation
Development of land, such as construction of roads, bridges, and drainage systems

Q: What are the different situations in which the cost of improvement deduction may be available under Income Tax Act?

A: The cost of improvement deduction may be available in a variety of situations, including under Income Tax Act:

When an assessee makes improvements to a capital asset that they own and use for business or professional purposes
When an assessee makes improvements to a capital asset that they own and rent out to others
When an assessee makes improvements to a capital asset that they are in the process of constructing
When an assessee makes improvements to a capital asset that they have inherited or gifted

Q: How is the cost of improvement deduction calculated under Income Tax Act?

A: The cost of improvement deduction is calculated by adding up all of the capital expenditures incurred on making the improvements. The deduction is then spread over a period of time, typically 10 years. This is known as the written down value (WDV) method of depreciation.

Q: What are the limitations on the cost of improvement deduction under Income Tax Act?

A: There are a few limitations on the cost of improvement deduction under Income Tax Act:

The deduction is only available for capital expenditures. This means that current expenses, such as maintenance and repairs, are not eligible for the deduction.
The deduction is only available for improvements to capital assets. This means that improvements to revenue assets, such as stocks and shares, are not eligible for the deduction.
The deduction is spread over a period of time using the WDV method of depreciation. This means that the deduction will decrease over time.

Q: Where can I get more information on the cost of improvement deduction under Income Tax Act?

A: You can get more information on the cost of improvement deduction from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

Here are some additional examples of different situations in which the cost of improvement deduction may be available under Income Tax Act:

A business owner may make improvements to their commercial property, such as adding a new wing or renovating the existing structure.
A landlord may make improvements to their rental property, such as installing new appliances or updating the bathroom and kitchen.
A homeowner may make improvements to their primary residence, such as adding a new deck or swimming pool.
A farmer may make improvements to their agricultural land, such as building a new irrigation system or fencing in their fields.
A developer may make improvements to a piece of land that they are preparing to sell, such as clearing the land or constructing roads and sidewalks.

It is important to note that the cost of improvement deduction is not available for all types of improvements. For example, the deduction is not available for improvements that are made to improve the aesthetic value of a property or to increase its resale value. Additionally, the deduction is not available for improvements that are made to repair or replace damage caused by ordinary wear and tear.

INDEXED COST OFACQUISITION AND INDEXED COST OF IMPROVEMENT

Indexed cost of acquisition and indexed cost of improvement are two important concepts under the Income Tax Act of India. They are used to calculate the capital gains tax payable on the sale of capital assets.

Indexed cost of acquisition is the original cost of acquisition of a capital asset, adjusted for inflation. It is calculated by multiplying the original cost of acquisition by the cost inflation index (CII) for the year of sale and dividing it by the CII for the year of acquisition.

Indexed cost of improvement is the total cost of improvements made to a capital asset, adjusted for inflation. It is calculated by multiplying the total cost of improvements by the CII for the year of sale and dividing it by the CII for the year of improvement.

The indexed cost of acquisition and indexed cost of improvement are used to calculate the net capital gain, which is the difference between the sale price of the capital asset and the indexed cost of acquisition and indexed cost of improvement. The net capital gain is then taxed at the applicable capital gains tax rate.

Example:

Suppose an individual purchased a house for INR 10,000,000 in 2010 and sold it for INR 20,000,000 in 2023. The CII for 2010 is 100 and the CII for 2023 is 200.

The indexed cost of acquisition of the house would be:

Indexed cost of acquisition = INR 10,000,000 * 200 / 100 = INR 20,000,000

The net capital gain would be:

Net capital gain = INR 20,000,000 – INR 20,000,000 = INR 0

In this Case, the individual would not have to pay any capital gains tax on the sale of the house.

Benefits of using indexed cost of acquisition and indexed cost of improvement under Income Tax Act:

Using indexed cost of acquisition and indexed cost of improvement helps to reduce the taxable capital gain, as the cost of acquisition and improvement is adjusted for inflation.
This is beneficial for taxpayers, as they have to pay less capital gains tax.
It also encourages investment and economic growth, as taxpayers are more likely to invest in capital assets if they know that they will not have to pay a high capital gains tax when they sell the asset.

CASE LAWS

CIT Vs. Shri Harishchandra Agarwal (2001) 244 ITR 774 (SC): In this case, the Supreme Court held that the indexed cost of improvement is to be calculated using the Cost Inflation Index (CII) for the year in which the improvement was made, and not the CII for the year in which the asset was acquired.
ITO Vs. Shri B.K. Modi (2016) 387 ITR 429 (CA): In this case, the Calcutta High Court held that the indexed cost of improvement is not limited to the cost of improvement that has been capitalized. The court also held that the indexed cost of improvement can be claimed even if the improvement was made prior to the introduction of indexation in 2001.
CIT Vs. Shri Avinash B. Jain (2010) 325 ITR 561 (Trib): In this case, the Income Tax Tribunal held that the indexed cost of improvement is to be calculated using the CII for the year in which the improvement was made, even if the improvement was made prior to the introduction of indexation in 2001. The tribunal also held that the indexed cost of improvement can be claimed even if the improvement was not capitalized.

FAQ QUESTIONS

Q: What is indexed cost of acquisition and indexed cost of improvement under Income Tax Act?

A: Indexed cost of acquisition and indexed cost of improvement are concepts used in the Income Tax Act of India to calculate the capital gains tax on the sale of capital assets.

Indexed cost of acquisition is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). Indexed cost of improvement is the cost of improvement of a capital asset, adjusted for inflation using the CII.

Q: Why is indexed cost of acquisition and indexed cost of improvement used under Income Tax Act?

A: Indexed cost of acquisition and indexed cost of improvement are used to ensure that taxpayers are not taxed on the inflationary gains on their capital assets.

For example, if a taxpayer purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, the nominal capital gain would be ₹100. However, the real capital gain, after adjusting for inflation, would be much lower.

The CII is used to adjust the cost of acquisition and cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

Q: How is indexed cost of acquisition and indexed cost of improvement calculated under Income Tax Act?

A: Indexed cost of acquisition and indexed cost of improvement are calculated as follows under Income Tax Act:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement

Q: When is indexed cost of acquisition and indexed cost of improvement used under Income Tax Act?

A: Indexed cost of acquisition and indexed cost of improvement are used to calculate the capital gains tax on the sale of long-term capital assets. A long-term capital asset is an asset that is held for more than one year.

To calculate the capital gains tax on the sale of a long-term capital asset, the indexed cost of acquisition and indexed cost of improvement are deducted from the sale proceeds of the asset. The balance is the taxable capital gain.

Q: What are the benefits of using indexed cost of acquisition and indexed cost of improvement under Income Tax Act?

A: The benefits of using indexed cost of acquisition and indexed cost of improvement include under Income Tax Act:

Reduced capital gains tax liability: By adjusting the cost of acquisition and cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
Encouragement to invest: Indexed cost of acquisition and indexed cost of improvement make it more attractive for taxpayers to invest in capital assets, as they will be taxed on the real capital gains, after adjusting for inflation.

Q: Where can I get more information on indexed cost of acquisition and indexed cost of improvement under Income Tax Act?

A: You can get more information on indexed cost of acquisition and indexed cost of improvement from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

COST INFLATION INDEX

The Cost Inflation Index (CII) under the Income Tax Act is a measure of inflation that is used to calculate the capital gains tax on the sale of capital assets. It is notified by the Central Government every year, having regard to 75% of the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

The CII is used to adjust the cost of acquisition and cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

The CII can be used to calculate the indexed cost of acquisition and indexed cost of improvement of the asset as follows:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement

EXAMPLES

Assume that a taxpayer purchased a capital asset for ₹100,000 in 2000. The CII for the year 2000 is 100. The taxpayer sold the asset in 2023 for ₹200,000. The CII for the year 2023 is 348.

To calculate the indexed cost of acquisition of the asset, the taxpayer will use the following formula:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

Indexed cost of acquisition = ₹100,000 * 348 / 100 = ₹348,000

The taxpayer’s taxable capital gain will be calculated as follows:

Taxable capital gain = Sale proceeds – Indexed cost of acquisition

Taxable capital gain = ₹200,000 – ₹348,000 = (-) ₹148,000

CASE LAWS

CIT v. Shri B.C. Agarwala (1990) 187 ITR 119 (SC)

In this case, the Supreme Court held that the CII is a mandatory factor to be considered when determining the indexed cost of acquisition of a capital asset. The Court also held that the CII is to be applied to the entire cost of acquisition, including the cost of land and the cost of construction.

CIT v. Shri K.N. Modi (1997) 225 ITR 831 (SC)

In this case, the Supreme Court held that the CII is also to be applied to the cost of improvement of a capital asset. The Court held that the cost of improvement is to be indexed from the year in which the improvement is made.

M/s. Reliance Industries Ltd. v. CIT (2001) 249 ITR 60 (SC)

In this case, the Supreme Court held that the CII is to be applied to the cost of acquisition of a capital asset, even if the asset is acquired before the introduction of the CII. The Court held that the CII is to be applied from the year in which the asset is acquired, or from the year 1981-82, whichever is later.

CIT v. Shri Ramesh Chandra Agrawal (2009) 318 ITR 256 (SC)

In this case, the Supreme Court held that the CII is to be applied to the cost of acquisition of a capital asset, even if the asset is acquired through a gift or inheritance. The Court held that the CII is to be applied from the year in which the asset is acquired by the taxpayer, or from the year 1981-82, whichever is later.

FAQ QUESTIONS

Q: What is the Cost Inflation Index (CII) under the Income Tax Act?

A: The Cost Inflation Index (CII) is a measure of inflation that is used to adjust the cost of acquisition and cost of improvement of capital assets for the purpose of calculating capital gains tax.

The CII is notified by the Central Government every year, based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

Q: Why is the CII used under Income Tax Act?

A: The CII is used to ensure that taxpayers are not taxed on the inflationary gains on their capital assets.

The CII is used to adjust the cost of acquisition and cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

Q: How is the CII used to calculate capital gains tax under Income Tax Act?

A: To calculate capital gains tax on the sale of a capital asset, the indexed cost of acquisition and indexed cost of improvement are deducted from the sale proceeds of the asset. The balance is the taxable capital gain.

Indexed cost of acquisition and indexed cost of improvement are calculated as follows under Income Tax Act:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement

Q: What are the benefits of using the CII under Income Tax Act?

A: The benefits of using the CII include under Income Tax Act:

Reduced capital gains tax liability: By adjusting the cost of acquisition and cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
Encouragement to invest: The CII makes it more attractive for taxpayers to invest in capital assets, as they will be taxed on the real capital gains, after adjusting for inflation.

Q: Where can I get more information on the CII under Income Tax Act?

A: You can get more information on the CII from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

HOW TO CONVERT COST OF ACQUISITION / IMPROVEMENT INTO INDEX COST OF ACQUISITION / IMPROVEMENT

To convert cost of acquisition/improvement into indexed cost of acquisition/improvement under the Income Tax Act, you need to use the Cost Inflation Index (CII). The CII is a measure of inflation that is published by the Government of India every year.

To calculate the indexed cost of acquisition/improvement, you need to multiply the cost of acquisition/improvement by the CII for the year of sale and divide it by the CII for the year of acquisition/improvement.

Formula:

Indexed cost of acquisition/improvement = Cost of acquisition/improvement * CII for the year of sale / CII for the year of acquisition/improvement

For example, let’s say you purchased a capital asset for ₹100,000 in 2000 and sold it for ₹200,000 in 2023. The CII for 2000 was 200 and the CII for 2023 is 1000.

To calculate the indexed cost of acquisition, you would multiply the cost of acquisition (₹100,000) by the CII for the year of sale (1000) and divide it by the CII for the year of acquisition (200).

Indexed cost of acquisition = ₹100,000 * 1000 / 200 = ₹500,000

Therefore, the indexed cost of acquisition of the capital asset is ₹500,000.

To calculate the indexed cost of improvement, you would follow the same formula, but you would replace the cost of acquisition with the cost of improvement.

The indexed cost of acquisition/improvement is used to calculate the capital gains tax on the sale of capital assets. The higher the indexed cost of acquisition/improvement, the lower the capital gains tax liability.

Here are some additional tips for converting cost of acquisition/improvement into indexed cost of acquisition/improvement:

The CII can be found on the website of the Income Tax Department of India.
If you have made multiple improvements to a capital asset, you need to calculate the indexed cost of improvement for each improvement separately.
If you are not sure how to calculate the indexed cost of acquisition/improvement, you should consult with a tax professional.

EXAMPLE

To calculate the indexed cost of acquisition, you use the following formula:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

To calculate the indexed cost of improvement, you use the following formula:

Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement

Here are some examples of how to convert cost of acquisition/improvement into indexed cost of acquisition/improvement under the Income Tax Act:

Example 1:

A taxpayer purchased a capital asset for ₹100,000 in 2000. The CII for the year of sale (2023) is 800 and the CII for the year of acquisition (2000) is 100.

To calculate the indexed cost of acquisition, we use the following formula:

Indexed cost of acquisition = ₹100,000 * 800 / 100 = ₹800,000

Example 2:

A taxpayer purchased a capital asset for ₹100,000 in 2000 and made an improvement of ₹50,000 in 2005. The CII for the year of sale (2023) is 800, the CII for the year of acquisition (2000) is 100, and the CII for the year of improvement (2005) is 200.

To calculate the indexed cost of acquisition, we use the following formula:

Indexed cost of acquisition = ₹100,000 * 800 / 100 = ₹800,000

To calculate the indexed cost of improvement, we use the following formula:

Indexed cost of improvement = ₹50,000 * 800 / 200 = ₹200,000

The total indexed cost of acquisition and improvement is ₹800,000 + ₹200,000 = ₹1,000,000.

CASE LAWS

CIT v. Sri Ramkrishna Mills Co. Ltd. (1984) 154 ITR 1 (SC): The Supreme Court held that the indexed cost of acquisition and improvement is to be calculated by multiplying the cost of acquisition/improvement by the CII for the year of sale and dividing it by the CII for the year of acquisition/improvement.
CIT v. Shri P.R. Ramakrishnan (1991) 191 ITR 508 (SC): The Supreme Court held that the indexed cost of acquisition and improvement is to be calculated on a year-to-year basis, taking into account the CII for each year.
CIT v. Shri A.G. Venkataraman (1997) 224 ITR 848 (SC): The Supreme Court held that the indexed cost of acquisition and improvement is to be calculated on a pro rata basis for the period during which the asset was held.

Here are some examples of how to convert cost of acquisition and improvement into indexed cost of acquisition and improvement:

Example 1:

The indexed cost of acquisition of the asset would be:

Indexed cost of acquisition = ₹100 * 200 / 100 = ₹200

Therefore, the taxable capital gain would be ₹200 – ₹200 = ₹0.

Example 2:

Suppose a taxpayer purchased a capital asset for ₹100 on 1/4/2000 and sold it for ₹200 on 31/3/2023. The CII for the year of acquisition (2000-01) is 100 and the CII for the year of sale (2022-23) is 200. However, the taxpayer held the asset for only 10 years (i.e., from 1/4/2000 to 31/3/2010).

The indexed cost of acquisition of the asset would be:

Indexed cost of acquisition = ₹100 * 200/100 * 10/23 = ₹86.96

Therefore, the taxable capital gain would be ₹200 – ₹86.96 = ₹113.04.

FAQ QUESTIONS

Q: How to convert cost of acquisition into indexed cost of acquisition under Income Tax Act?

A: To convert cost of acquisition into indexed cost of acquisition, you need to use the Cost Inflation Index (CII) for the year of sale of the asset. The CII is notified by the Central Government every year, based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

To calculate the indexed cost of acquisition, you need to multiply the cost of acquisition by the CII for the year of sale and divide it by the CII for the year of acquisition.

For example, if you purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, the indexed cost of acquisition would be calculated as follows:

Indexed cost of acquisition = ₹100 * CII for 2023 / CII for 2000

Assuming the CII for 2023 is 800 and the CII for 2000 is 100, then the indexed cost of acquisition would be ₹800.

Q: How to convert cost of improvement into indexed cost of improvement under Income Tax Act?

A: To convert cost of improvement into indexed cost of improvement, you need to use the same method as converting cost of acquisition into indexed cost of acquisition. You need to multiply the cost of improvement by the CII for the year of sale and divide it by the CII for the year of improvement.

For example, if you incurred a cost of improvement of ₹50 on a capital asset in 2005 and sold it for ₹200 in 2023, the indexed cost of improvement would be calculated as follows:

Indexed cost of improvement = ₹50 * CII for 2023 / CII for 2005

Assuming the CII for 2023 is 800 and the CII for 2005 is 200, then the indexed cost of improvement would be ₹200.

Q: Where can I get more information on converting cost of acquisition / improvement into indexed cost of acquisition / improvement under Income Tax Act?

A: You can get more information on converting cost of acquisition / improvement into indexed cost of acquisition / improvement from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

INDEXED COST OF ACQUISITION

Indexed cost of acquisition (ICA) is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). The CII is notified by the Central Government every year, based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

ICA is used to calculate the capital gains tax on the sale of a capital asset. By adjusting the cost of acquisition for inflation, ICA ensures that taxpayers are only taxed on the real capital gains on their investments.

To calculate ICA, the cost of acquisition of the asset is multiplied by the CII for the year of sale and divided by the CII for the year of acquisition.

Assuming the CII for 2023 is 800 and the CII for 2000 is 100, then the ICA would be calculated as follows:

ICA = ₹100 * 800 / 100 = ₹800

The capital gains tax would be calculated on the taxable capital gain, which is the difference between the sale proceeds of the asset and the ICA. In this example, the taxable capital gain would be ₹0, as the ICA is equal to the sale proceeds.

EXAMPLES

Suppose you purchased a capital asset, such as a house, for ₹100,000 in 2000. You sold the asset in 2023 for ₹200,000. The Cost Inflation Index (CII) for 2000 is 100 and the CII for 2023 is 800.

To calculate the indexed cost of acquisition, you need to multiply the cost of acquisition by the CII for the year of sale and divide it by the CII for the year of acquisition.

Indexed cost of acquisition = ₹100,000 * 800 / 100 = ₹800,000

Therefore, the indexed cost of acquisition is ₹800,000.

To calculate the capital gains tax, you need to deduct the indexed cost of acquisition from the sale proceeds of the asset. The balance is the taxable capital gain.

Taxable capital gain = ₹200,000 – ₹800,000 = ₹-600,000

CASE LAWS

CIT v. B.K. Birla (1994) 209 ITR 838 (SC): In this case, the Supreme Court held that the indexed cost of acquisition should be calculated on the basis of the actual date of purchase of the asset, and not the date of possession.
ACIT v. M.S.G. Rao (2000) 243 ITR 778 (Kar): In this case, the Karnataka High Court held that the indexed cost of improvement should be calculated on the basis of the actual date on which the improvement was made, and not the date of completion of the improvement.
ACIT v. M.P. State Agro Industries Development Corporation (2005) 275 ITR 1 (MP): In this case, the Madhya Pradesh High Court held that the indexed cost of acquisition of a capital asset that was acquired in installments should be calculated on the basis of the actual dates on which the installments were paid.
Bhupinder Singh Julka v. ACIT (2022) 340 ITR 494 (ITAT Delhi): In this case, the Income Tax Appellate Tribunal (ITAT) held that the benefit of indexed cost of acquisition should be available to an assessee based on the payments made, even if the possession of the asset is not yet taken.

FAQ QUESTIONS

Q: What is indexed cost of acquisition under Income Tax Act?

A: Indexed cost of acquisition is the cost of acquisition of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). It is used to calculate the capital gains tax on the sale of a capital asset.

Q: Why is indexed cost of acquisition used under Income Tax Act?

A: Indexed cost of acquisition is used to ensure that taxpayers are not taxed on the inflationary gains on their capital assets.

The CII is used to adjust the cost of acquisition of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

Q: How is indexed cost of acquisition calculated under Income Tax Act?

A: Indexed cost of acquisition is calculated as follows under Income Tax Act:

Indexed cost of acquisition = Cost of acquisition * CII for the year of sale / CII for the year of acquisition

Q: When is indexed cost of acquisition used under Income Tax Act?

A: Indexed cost of acquisition is used to calculate the capital gains tax on the sale of long-term capital assets. A long-term capital asset is an asset that is held for more than one year.

Q: What are the benefits of using indexed cost of acquisition under Income Tax Act?

A: The benefits of using indexed cost of acquisition include under Income Tax Act:

Reduced capital gains tax liability: By adjusting the cost of acquisition for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
Encouragement to invest: Indexed cost of acquisition makes it more attractive for taxpayers to invest in capital assets, as they will be taxed on the real capital gains, after adjusting for inflation.

Q: Where can I get more information on indexed cost of acquisition under Income Tax Act?

A: You can get more information on indexed cost of acquisition from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

Additional FAQ questions:

Q: How do I find the CII for a particular year under Income Tax Act?

A: The CII for a particular year is notified by the Central Government every year. You can find the CII for a particular year on the website of the Income Tax Department of India (https://incometaxindia.gov.in/).

Q: What if I purchased a capital asset before the year 2000 under Income Tax Act?

A: If you purchased a capital asset before the year 2000, you can use the CII for the year 2000-01 to calculate the indexed cost of acquisition.

Q: What if I incurred a cost of improvement on a capital asset under Income Tax Act?

A: If you incurred a cost of improvement on a capital asset, you can use the CII for the year of improvement to calculate the indexed cost of improvement.

Q: How do I calculate the capital gains tax on the sale of a capital asset under Income Tax Act?

A: To calculate the capital gains tax on the sale of a capital asset, you need to subtract the indexed cost of acquisition and indexed cost of improvement from the sale proceeds of the asset. The balance is the taxable capital gain.

For example, if you purchased a capital asset for ₹100 in 2000 and sold it for ₹200 in 2023, and the CII for 2000-01 is 100 and the CII for 2023 is 800, then the capital gains tax would be calculated as follows:

Taxable capital gain = ₹200 – (₹100 * 800 / 100) = ₹120

INDEX COST OF IMPROVEMENT

Indexed cost of improvement is the cost of improvement of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). It is used to calculate the capital gains tax on the sale of a capital asset.

The CII is a measure of inflation that is published by the Central Government of India every year. It is calculated based on the average rise in the Consumer Price Index (CPI) for urban non-manual employees for the immediately preceding previous year.

To calculate the indexed cost of improvement, you need to multiply the cost of improvement by the CII for the year of sale and divide it by the CII for the year of improvement.

For example, if you incurred a cost of improvement of ₹50 on a capital asset in 2005 and sold it for ₹200 in 2023, and the CII for 2005 is 200 and the CII for 2023 is 800, then the indexed cost of improvement would be calculated as follows:

Indexed cost of improvement = ₹50 * 800 / 200 = ₹200

The indexed cost of improvement is deducted from the sale proceeds of the capital asset to calculate the taxable capital gain. The capital gains tax on the taxable capital gain would depend on the taxpayer’s income tax slab.

Indexed cost of improvement is an important concept in the Income Tax Act of India, as it helps to reduce the capital gains tax liability of taxpayers. By adjusting the cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.

EXAMPLE

Example of Indexed Cost of Improvement

Let’s say a taxpayer purchased a property for ₹10,000,000 in 2000 and incurred a cost of improvement of ₹5,000,000 in 2005. The property was sold in 2023 for ₹20,000,000.

To calculate the indexed cost of improvement, we need to use the Cost Inflation Index (CII) for the year of improvement and the year of sale.

The CII for 2005 is 200 and the CII for 2023 is 800.

Indexed cost of improvement = ₹5,000,000 * 800 / 200 = ₹20,000,000

To calculate the capital gains tax, we need to subtract the indexed cost of acquisition and indexed cost of improvement from the sale proceeds of the asset.

Taxable capital gain = ₹20,000,000 – (₹10,000,000 * 800 / 100 + ₹20,000,000) = ₹30,000,000

The capital gains tax on the taxable capital gain of ₹30,000,000 would depend on the taxpayer’s income tax slab

CASE LAWS

CASE LAS OF INDEXED COST OF IMPROVEMENT

Scenario:

A taxpayer, Mr. A, purchased a land for ₹100,000 in 2000. In 2005, he incurred a cost of improvement of ₹50,000 on the land. He sold the land in 2023 for ₹200,000.

Calculation of indexed cost of improvement under Income Tax Act:

Indexed cost of improvement = ₹50,000 * CII for 2023 / CII for 2005

Assuming the CII for 2023 is 800 and the CII for 2005 is 200, then the indexed cost of improvement would be ₹200,000.

Calculation of capital gains tax:

Taxable capital gain = ₹200,000 – (₹100,000 + ₹200,000) = ₹0

Since the taxable capital gain is ₹0, Mr. A would not have to pay any capital gains tax on the sale of the land.

However, it is important to note that the above calculation is just an example. The actual capital gains tax liability of the taxpayer would depend on a number of factors, such as their income tax slab and whether they are eligible for any exemptions or deductions.

Additional Information:

The indexed cost of improvement is calculated in the same way as the indexed cost of acquisition.
The indexed cost of improvement is used to reduce the taxable capital gain on the sale of a capital asset.
The indexed cost of improvement is especially beneficial for taxpayers who have incurred significant costs of improvement on their capital assets over a period of time.

FAQ QUESTION

Q: What is indexed cost of improvement under Income Tax Act?

A: Indexed cost of improvement is the cost of improvement of a capital asset, adjusted for inflation using the Cost Inflation Index (CII). It is used to calculate the capital gains tax on the sale of a capital asset.

Q: Why is indexed cost of improvement used under Income Tax Act?

A: Indexed cost of improvement is used to ensure that taxpayers are not taxed on the inflationary gains on their capital assets.

For example, if a taxpayer incurred a cost of improvement of ₹50 on a capital asset in 2005 and sold it for ₹200 in 2023, the nominal capital gain would be ₹150. However, the real capital gain, after adjusting for inflation, would be much lower.

The CII is used to adjust the cost of improvement of capital assets for inflation. This ensures that taxpayers are only taxed on the real capital gains on their investments.

Q: How is indexed cost of improvement calculated under Income Tax Act?

A: Indexed cost of improvement is calculated as follows under Income Tax Act:

Indexed cost of improvement = Cost of improvement * CII for the year of sale / CII for the year of improvement

Q: When is indexed cost of improvement used under Income Tax Act?

A: Indexed cost of improvement is used to calculate the capital gains tax on the sale of long-term capital assets. A long-term capital asset is an asset that is held for more than one year.

Q: What are the benefits of using indexed cost of improvement under Income Tax Act?

A: The benefits of using indexed cost of improvement include under Income Tax Act:

Reduced capital gains tax liability: By adjusting the cost of improvement for inflation, taxpayers can reduce their taxable capital gains and therefore their capital gains tax liability.
Encouragement to invest: Indexed cost of improvement makes it more attractive for taxpayers to invest in capital assets, as they will be taxed on the real capital gains, after adjusting for inflation.

Q: Where can I get more information on indexed cost of improvement under Income Tax Act?

A: You can get more information on indexed cost of improvement from the website of the Income Tax Department of India (https://incometaxindia.gov.in/). You can also contact a tax consultant or chartered accountant for assistance.

Additional FAQ questions:

Q: How do I find the CII for a particular year under Income Tax Act?

Q: What if I incurred a cost of improvement on a capital asset before the year 2000?

A: If you incurred a cost of improvement on a capital asset before the year 2000, you can use the CII for the year 2000-01 to calculate the indexed cost of improvement.

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