Indexation – When and How it Works

Introduction

Indexation adjusts the purchase price of your investment for inflation — helping you reduce taxable capital gains. It used to be a powerful tool in debt mutual funds. But recent tax changes have made it applicable to only older investments and specific asset classes. Let’s understand how it works with numbers.

What Is Indexation?

Indexation uses the Cost Inflation Index (CII) published by the Income Tax Department. Indexed Cost Formula: Indexed Cost = Purchase Price × (CII of Sale Year / CII of Purchase Year) This helps lower the taxable gain, reducing the 20% LTCG tax on non-equity investments held for 3+ years. 

  Real-Life Example: Ganesh’s Debt Fund Ganesh invested ₹2,00,000 in March 2019 (CII = 280) and redeemed in April 2023 (CII = 331).

Indexed Cost = ₹2,00,000 × (331 / 280) = ₹2,36,428

Redemption Value = ₹2,80,000

 Without indexation, the tax would’ve been ₹16,000. 

 👉 Saved ₹7,286 due to indexation. When Can You Use Indexation? 

 ✅ Only for investments before April 1, 2023, in:

• Debt Mutual Funds (held >3 years)
• Gold ETFs
• International Mutual Funds

Conclusion

Indexation helps beat inflation in taxes — but it’s now limited to legacy investments. Going forward, investors must plan keeping slab taxation in mind. 

 If you have older debt fund investments, hold them till 3 years to enjoy indexation. For new investments, assess if the slab rate still justifies debt mutual fund exposure.

Summary Table: Indexation Snapshot