Taxes balance and boost our economies, and from simple taxes, we have now evolved into a system of multiple taxes with varying percentages. Currently, all salaried individuals earning more than Rs.2.5 lakh per annum are required to pay income tax. It is the duty of every working individual to pay taxes. Only then can you morally benefit from the government’s services. Capital gains tax falls under the direct tax quota. This is the tax collected by the government based on the income from the sale of property, gold, shares, and bonds.
Salma Rishab bought a furnished apartment in Mumbai for Rs.25 lakh twenty years ago. She recently sold it for Rs.95 lakh. The actual profit is Rs.70 lakh, on which Salma will need to pay a large amount of tax. However, with indexing, the purchase price is adjusted for inflation, based on the current price and the gain is then calculated. The current rate is governed by a factor called as Cost Inflation Index (CII). The CII is provided and updated by the income tax department every year. Using this tool, one can calculate the updated price of their investment. The capital gain on Salma’s flat is not Rs.70 lakh, as it is adjusted with the price of the property, according to current figures. This adjusted purchase price is called as an indexed cost of acquisition. If the indexed cost of acquisition on her flat is Rs.57 lakh, then she will need to pay taxes in accordance with the profit made, which is Rs.38 lakh.
The income tax department allows for the adjustment of your long-term assets and other investments based on inflation. The definition of long-term status for physical gold and real estate sector is 36 months. Whereas, for capital assets like equity funds and shares, the investment gets a status of long-term after one year. Indexing is extremely useful while making investments in gold, stocks and the real estate sector. Another investment that benefits from indexing is the debt mutual fund sector.
Double Indexing and how they affect taxes
A more efficient way to save taxes is undoubtedly the method of double indexing. This involves investing in equity funds before the end of the financial year. The investment must be sold within a month after the end of the next financial year. For example, you invest during February 2015, you need to exit in April 2017. Equity oriented funds can reach long-term status after a year’s investment. The capital gains on equity funds are tax-free for long-term investments. Hence, the proposition of double indexation can be applied on them.
Fixed maturity plans (FMPs) are a popular choice for double indexing. Double indexation effectively considers your mutual funds as a three-year investment and therefore, saves you from regular taxation.
Debt funds fall under the category of non-equity funds and the holding period and the tax rate is different from equity funds. The long-term holding period for a debt mutual fund is 36 months. The capital gains for this is taxed at 10%, compared with 20% for short-term capital gains.
How is double indexation useful?
Double indexation can help in reducing your tax output and is also a smarter way of managing your funds. As mentioned earlier, FMP is an ideal option to invest funds, as it allows you to enjoy the benefits of double indexation. They are similar to fixed deposits, as they are locked down for a fixed tenor with a closed structure. With double indexation, one can get higher returns on FMPs, when compared to fixed deposits. The taxation benefits over FD are also obvious.
In conclusion, one can say that double indexing is a simple, yet powerful way to save taxes. When used effectively, it saves your hard-earned money and reduces the burden of unnecessary taxation.