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What is Indexation & How does it Work?​

When you invest in a mutual fund scheme, the returns that you get at the end of your investment tenure are called capital gains; and the tax that you pay on these gains is called the capital gain tax. Indexation is a tool employed to reduce the burden of this capital gain tax, so that you pay a lesser amount as tax. The tool does this by adjusting your original investment value against inflation.

Benefit of indexation is available only for long term capital gain from Other Than Equity Oriented mutual fund schemesin mutual funds to resident investor as follows:

How does indexation work?

For example, let us assume that you invested Rs 2,00,000 in a Other than Equity Oriented mutual fund scheme in May’16; and at the time of redemption after 3 years in Oct’19, the value of your investment has become Rs 2,20,000. Now, your capital gain= Rs 2,20,000- Rs 2,00,000= Rs 20,000. And this amount will be liable forlong-termcapital gain tax. What indexation does, for the purpose of tax calculation is, that it adjusts your purchasing price of Rs.2,00,000 as per inflation so that your purchase price increases and reduce capital gain for tax purpose.

CII is the cost of inflation index notified values for the years 2016-17 and 2019-20 in the above example,

Indexed purchase price= (289/264) * 2,00,000= Rs 2,18,939.3939

Now recalculating capital gains with the indexed purchase price-

Capital gains= Rs 2,20,000- Rs 2,18,939.39.39= Rs 1060.6061

In this illustrative example, indexation has managed to bring down your LTCG by 94.6969%, which is a huge leap saving.

In conclusion-

The tax benefit that indexation can offer to Other Than Equity Oriented Mutual Fund Scheme to a resident investor is fairly considerable, and hence, it may be in your interest to hold on to your debt scheme investment for a period higher than 36months. Debt schemes also help you in keeping your portfolio diversified while not introducing relatively higher risks in it. While redeeming, you are advised to consider the tax implication of withdrawal by calculating the payable capital gains tax in both short-term and long-term scenarios.

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Disclaimer:
Helpful information for investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/ Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in . For more info on KYC, change in various details & redressal of complaints, visit mf.nipponindiaim.com/investoreducation/what-to-know-when-investing This is an investor education and awareness initiative by Nippon India Mutual Fund.

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document. Language Disclaimer:
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