Sunday, June 28, 2009

Double dipping on the cost of inflation index

Our economy has the concept of cost of inflation index that allows the common man to factor in inflation on long term asset sales. The way it work is by leveraging a Cost of inflation index (CII) that is a number that is notified each year by the government starting from year 1981-1982. The way to use this number to calculate your inflated cost is as follows

  • Inflated cost of purchase = original cost of purchase *(CII for the year of purchase/CII for the year of sale)
  • Capital gains tax = 20% * (Actual sale price - Inflated cost price)

Now I did a quick math to see what is the inflated cost price for a two year window and you can see the results yourself below. The cost price varies between 22% increase to a lowest of 7%. So what is the big deal do you say? Well if you consider the fact that if you have say a debt investment for a period of > 365 days timed right say buy on March last week and then sell on April of the following year in the first week, you can double dip on the CII effectively allowing you to get this fabulous 7% to 22% inflation of your purchase cost. Given that debt funds will return about 8%-10% in that time period, we have effectively managed to avoid the tax to be paid on this return.


Radek said...

Well, this is well exploited by most of FMPs. That is why we see so many FMPs annonced for 13 to 16 months between Jan to March year. All openly advertise about double indexation benefit.

Home Loans said...

Very attractive way of delivering information specially in formulas format.

RB @ RichBy30RetireBy40 said...

Hey guys, greetings from California! I was in Mumbai last November for a business conference, and am excited about India.

Quick question... when I was there last year, I asked why didn't everybody just put their money in 11%-12% savings. Locals said, that's nothing, and it's all about equities. But, 12% doubles your money every 6.5 years!

Is that not good enough?



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