How is indexation in mutual funds calculated and which schemes are eligible?
When you sell mutual fund units, you have to pay tax on the profit. This profit is known as capital gains and the tax paid on such profit is known as capital gains tax. For example, if you purchase mutual fund units for Rs 5000 and sell at Rs 6000, you will have to pay tax on the gain of Rs 1000. However, the rate at which this capital gains tax is levied depends on the period of holding and the type of the fund.
Indexation comes into play while calculating the net tax liability on capital gains. The indexation provision under the Income Tax Act helps in reducing the profit gap between the purchase price and the sale price on account of inflation, which in turn reduces the net tax payable.
With indexation, you can inflate the purchase price by a government-notified inflation factor, which is known as the Cost Inflation Index. When the purchase price increases, the total profit comes down, which also reduces the capital gain tax liability. But there is a catch. To be eligible for the indexation benefit, you need to invest in the growth option of the fund and remain invested for a minimum period of 3 years.
Let’s understand this with an example:
Suppose X purchased a mutual fund unit in October 2018 when its NAV was Rs 500 and redeemed in October 2023 when the NAV was Rs 800. As X remained invested for more than 3 years, he will be eligible for indexation benefit.
As per the Income Tax Department’s website, the CII for 2018-19 was 280. For the redemption year 2023-24, it is 348 (provisional).
For tax liability calculation, the purchase cost can be indexed up with reference to the CII in 2023-24 divided by the CII in 2018-19 i.e. 348/280xRs 500 = Rs 621. The tax liability here will be on the difference between the
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