What is Indexation?

Indexation is the process through which the purchase price of an asset is adjusted to account for inflation over time. It reduces your overall tax liability by adjusting the purchase price.

With respect to taxation, indexation benefits are applicable to unlisted bonds & debentures.

For example:
  • Mr Vipin invested Rs. 10 lakhs in an unlisted bond in May 2013.
  • In Feb 2021, he redeems this investments for Rs.15 lakhs and makes a capital gain of Rs. 5 lakhs.
  • Since the investment was held for more than 3 years, the gain on his investment is categorised as a Long Term Capital Gain (LTCG). Hence, the gain of Rs. 5 lakhs is eligible for indexation. 

To find taxable gains after accounting for indexation benefits, the original purchase price is adjusted for inflation using the Cost Inflation Index (CII). 

Inflation Adjusted Purchase Price  =  Purchase Price x (CII of the sale year / CII of the purchase year)
For example: 

Investment in May 2013 (FY 2013-14)
Rs. 10,00,000
CII for FY 2013-14 (Purchase year)
Sale Value in Feb 2021 (FY 2020-21)
Rs. 15,00,000
CII for FY 2020-21 (Sale Year)
Inflation-adjusted Purchase Price
10,00,000 x (301/220) = Rs. 13,68,182
Taxable Capital Gains (after indexation)
15,00,000 - 13,68,182 = Rs. 1,31,818

In the case of LTCG on unlisted bonds & debentures, tax liability is computed using two methods. Investors can choose the rate that is more beneficial to them:
  • 20% of gains (plus surcharge), with indexation benefits
  • 10% of gains (plus surcharge), without indexation benefits

The table below shows the difference between capital gains tax payable by Mr. Vipin with and without indexation benefits:

ParticularsWithout IndexationWith Indexation
Purchase Price
Rs. 10,00,000 
Rs. 10,00,000 
Inflation-adjusted Purchase Price  -Rs. 13,68,182
Sale Value
Rs. 15,00,000 Rs. 15,00,000 
Capital Gain 
Rs. 5,00,000
Rs. 1,31,818
Applicable Tax Rate
Tax Liability 
Rs. 26,363.6 
Rs. 26,363.6 

As you can see, Mr Vipin's tax liability is reduced by Rs. 23,636.6 with the benefit of indexation applicable to LTCG on unlisted bonds. 

Still need help? Create Ticket