Tax season is here! People are wondering how to lower tax liability. There are several norms crafted by the Income Tax Department. However, the applicability has certain rules and restrictions. They come with complications, so it is the go-to method for laymen.

As a result, either they have to consult experts for that or deprived from taking benefits. Here, in this article, we come up with Indexation, an important concept in ITR that can benefit you often.

How Indexation Is Important?

Are you concerned about inflation eating into your investment returns? Do you wonder how income tax laws factor in inflation when calculating capital gains on your investments? Here’s a solution: Indexation.

How It Is Beneficial?

The next question that may hit your mind is how it is beneficial. So, Indexation is a crucial method that helps investors mitigate the impact of inflation on their investment gains.

How It Can Lower Your Tax Liability?

By adjusting the purchase price of an asset or investment to account for inflation, indexation ensures that you pay taxes only on the actual gains adjusted for inflation, thereby reducing your overall tax liability.

How Indexation Works?

Indexation adjusts the purchase price of your investment to reflect the impact of inflation. This adjustment is based on the government’s Cost Inflation Index (CII), which provides the inflation rate for each financial year. A higher indexed purchase price results in lower taxable gains, thereby reducing your tax liability.

Here are key terms you need to understand. These are inflation, purchasing power, and capital gains as Indexation associated on it.

What Are Inflation and Purchasing Power?

Inflation refers to the gradual increase in the prices of goods and services over time. For instance, what costs Rs 100 today might cost Rs 110 or more in the following year due to inflation. This erosion in purchasing power means your money buys fewer goods and services each year.

What Are Capital Gains?

Capital gains are the profits you earn from the sale of an investment. It is calculated as the difference between the purchase price (cost) and the selling price.

What Are Benefits of Indexation?

Lower Tax Liability

By using indexation, investors can significantly reduce their tax liability on long-term capital gains.

Comparative Advantage

Debt funds, with their indexation benefits, offer a more tax-efficient investment option compared to traditional fixed deposits (FDs).