What Is the Indexation in Mutual Funds?

 


Indexation is a tax adjustment technique used to reduce the tax burden on long-term investments by accounting for inflation. It adjusts the purchase price of an asset, such as mutual funds, bonds, or real estate, to reflect the impact of inflation, thereby lowering the taxable capital gains. This adjustment is particularly relevant in India for investments held for more than three years, as it helps investors protect their returns from being eroded by inflation.

The Cost Inflation Index (CII), published annually by the Government of India, is used for calculating the indexed cost of acquisition. By multiplying the original purchase price of the asset by the CII, investors can determine the inflation-adjusted purchase price, which is then used to calculate the capital gains. The higher the indexed cost, the lower the capital gains, which ultimately reduces the tax payable.

Indexation benefits are especially significant for debt mutual funds, fixed maturity plans, and other non-equity investments, where long-term capital gains are taxed at 20% with indexation. This method not only lowers the tax liability but also enhances the overall post-tax returns for investors. Indexation encourages long-term investing by making it more tax-efficient, helping investors preserve and grow their wealth in a tax-friendly manner.

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