You need to hold investments like Property, Gold, Non-equity oriented Mutual Funds like Debt fund for 3 years to be considered as LTCG; otherwise, it falls under STCG. Indexation factors in the inflation of your investment.
Let’s consider a debt mutual fund you bought at 2011 with 100000. These are considered LTCG only if the holding period is more than 3 years only. Hypothetically, let’s say we sell this mutual fund at 300000 in 2015.
How will you find the LTCG and tax?
Previously, the LTCG was simply 3L-1L = 2L and the tax was flat 20% without indexation i.e. 20% of (3L-1L) = 40K. So 40K would go to tax.
Now you need to use https://www.incometaxindia.gov.in/charts%20%20tables/cost-inflation-index.htm to get the values of CII (The cost inflation index (CII) are fixed by Government of India in its official Gazette to measure inflation.)
- CII of the year of purchase = CII of the year of 2011 = 184
- CII of the year of sale = CII of the year of 2015 = 254
Inflation-adjusted buy value = Buy value * (CII of the year of sale)/(CII of the year of purchase) = 100000 * (254/184) = 138043.478
Now, LTGC with indexation = 3L – inflation adjusted buy value = 3L – 138043.478 = 161956.522
So, the tax will be = 20% of 161956.522 = 32391.3044 ~ 32391 INR. You can be saving 40000-32391 = 7609 INR from this new indexation method.