Shifting of Base Year from 1981 to 2001 for Capital Gains Tax Computation

Any person who is selling real estate, shares, or jewellery that is owned by him/her, needs to pay income tax on gains. Such gains are taxed under the head ‘capital gains’. Capital gains is nothing but profit on sale of capital assets. Capital assets are defined to include real estate, stocks, shares, bonds, and jewellery. 

Budget 2024 Latest Updates

Budget 2024 has passed the following amendments effective from FY 2024-25 - 

• For classifying assets into long-term and short-term, there will only be two holding periods: 12 months and 24 months. The 36-month holding period has been removed.
• The holding period for all listed securities is 12 months. All listed securities with a holding period exceeding 12 months are considered Long-Term. The holding period for all other assets is 24 months.
• The taxation of Short-Term Capital Gain for listed equity shares, a unit of an equity-oriented fund, and a unit of a business trust has been increased to 20% from 15%. Other financial and non-financial assets which are held for short term shall continue to attract the tax at slab rates.
• For the benefit of the lower and middle-income classes, the limit on the exemption of Long-Term Capital Gains on the transfer of equity shares or equity-oriented units or units of Business Trust has increased from Rs.1 Lakh to Rs.1.25 lakh per year. However, the rate at which it is taxed has increased from 10% to 12.5%. The exemption limit to Rs.1.25 lakhs has been increased for the whole of the year, whereas the tax rate changed on 23rd July 2024.
• The tax on other assets is reduced from 20% to 12.5% with effect from 23rd July 2024. On the other hand, the indexation benefit that previously was available on the sale of long-term assets has now been eliminated. However, the Government has given taxpayers an option to compute taxes on real estate transactions purchased before 23rd July 2024 either at 12.5% without indexation or at 20% with indexation. 

The Income Tax Act defines what is capital gain and what kind of assets are covered for the purpose of taxing capital gains. It also provides a method for computation of capital gains. Capital gains is divided into short-term and long-term capital gains depending upon the period for which an asset is being held and method of computation varies based on the nature of capital gain. 

The method for computing the capital gains is as follows:  

 Long-term capital gain is computed by deducting indexed cost of acquisition and indexed cost of improvement. 

What is Indexed Cost of Acquisition

Due to economic factors, the value of asset/any item inflates over a period of time. One kilogram of apples costs Rs.200 in 2018, but may have been available at less than half the price in 2001. Hence, it may not be fair to tax gains which is computed without factoring this inflation.

Therefore, Cost Inflation Index (CII) is fixed by the Government of India in its official gazette to measure inflation and is used in computing long-term capital gains in relation to the sale of assets. Indexation means adjustment in the cost of a capital asset based on the CII. This inflated cost is considered to be the cost of acquisition while computing profit or loss on the sale of capital asset.

Thus, indexation helps reflect the actual value of the asset at present market rates taking into account the erosion of value due to inflation. CII helps in saving tax by adjusting the purchasing price of the assets sold with the current market prices. It is to be note that as per Budget 2024, the indexation benefit that previously was available on sale of long-term assets, has now been done away with. However, the Government has given taxpayers an option to compute taxes on real estate transactions purchased before 23rd July 2024 either at 12.5% without indexation or at 20% with indexation. 

Computing Indexed Cost of Acquisition

Formula for computation of indexed cost of acquisition is as under: 

What is the Base Year

The government has fixed a particular calendar year as base year and fixes the CII starting from that base year. In case of assets acquired prior to the base year, taxpayer has an option to choose either Fair Market Value (FMV) as on the first day of base year or actual cost to arrive at indexed cost and compute capital gain/loss.

At present, the base year is fixed at 2001 and CII for the base year starts at 100 and keeps increasing every year. Further, a taxpayer is allowed to claim a deduction of the indexed cost of improvement incurred from base year onwards as FMV is considered as on the starting day of the base year itself accounts for cost of improvement undertaken prior to base year.

FMV is an estimate of the market value of an asset such as property or gold based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. The FMV can be obtained from the registered valuer. As FMV is generally higher than the original cost for many assets, the taxpayer is benefitted by considering FMV to arrive at the indexed cost of acquisition.

Shift of Base Year from 1981 to 2001

Prior to the Finance Act, 2017, the base year for fixing CII was 1981. The Finance Act, 2017 shifted the base year from 1981 to 2001. The reason for the shift is the genuine hardship/difficulty that was placed on taxpayers in computing capital gains due to the unavailability of relevant information for computation of Fair Market Value (FMV) of assets as on 1 April 1981 which is more than 3 decades old.

Currently, the base year is fixed at 2001 and CII for 2001 starts at 100. The cost of acquisition of an asset acquired before 1 April 2001 shall be allowed to be taken as FMV as on 1st April, 2001 or the actual cost as chosen by the taxpayer. The cost of improvement shall include only those capital expenses which are incurred after 1 April 2001.

Shifting the base year from 1981 to 2001 helped to capture the inflated cost of the property much better, reducing capital gains and the tax burden.

The CII notification links are given below:

• Base year 2001
• Prior to Finance Act 2017 having base year as 1981 (Note that this is no longer relevant for calculation of capital gains tax).

Impact of Shift of Base Year

Though the shift of base year is applicable to all capital assets, the impact of the shift depends on the nature of the asset and its appreciation in value over a period of time. 

Long-term capital gain would be less under the base year 2001 if appreciation in the price of asset is more than the increase in CII between the year of acquisition and 2001. 

Real estate owners who had acquired property prior to the base year, 2001 would probably benefit from the shift in the base year because of high appreciation value of the property. 

Let us understand the same with the help of an illustration: 

Mr. A purchased capital asset for Rs.45 lakh in September 1990 and sold the same for Rs.3 crore. Let us analyse the impact of the change under the following 3 scenarios:

• Sale is made during FY 2016-17 when the base year had not been shifted.
• Sale made in FY 2017-18 after the base has been shifted to 2001 and where the FMV as on 1 April 2001 is greater than the cost of acquisition.
• Sale made in FY 2017-18 after the base has been shifted to 2001 and where the FMV as on 1 April 2001 is lesser than the cost of acquisition.

Note: For computing the Indexed Cost of Acquisition for the FY 2016-17, the old CII has been adopted, while the Indexed Cost of Acquisition for FY 2017-18 has been computed adopting the new CII notified vide Notification no. So 1790(e)[no. 44/2017 (f. No. 370142/11/2017-tpl)], dated 5-6-2017.

The above table gives us an idea on how the capital gains drastically varies from one scenario to another. However, as already discussed above, the taxpayer has the option to choose between the FMV or the cost of acquisition, whichever would be more beneficial to him. 

Related Articles:

Capital Gains Tax

Long-term capital gains

Short-term capital gain

Tax on Long-term Capital Gains on Equity Funds

Short Term Capital Gain on Shares

Capital Gains Exemption

Section 54F