How to adjust tax liabilities for inflation
What's the story
Inflation affects everyone, including the economy and taxes.
India's Income Tax Act has provisions to adjust tax liabilities for inflation.
These adjustments ensure taxpayers aren't burdened with extra costs due to inflation's erosion of purchasing power.
This article delves into the crucial sections of the Act that facilitate these adjustments, providing a clear understanding of how inflation plays a role in your tax calculations.
Indexation
Indexation benefit on capital gains
One major way taxes account for inflation is through the indexation benefit on long-term capital gains.
When you sell an asset held for more than two years, you can use indexation to adjust the purchase price of your asset based on the Cost Inflation Index (CII) released by the government.
This adjusted cost is then used to calculate capital gains, lowering your tax liability by factoring in inflation.
Slab adjustments
Revised slab rates and exemptions
The government regularly adjusts income tax slab rates and exemption limits to account for inflation and rising living costs.
For example, budget announcements frequently raise the basic exemption limit or implement new rebates under Section 87A for lower-income individuals.
These changes aim to protect taxpayers by preventing inflation from eroding their real income before it is subject to taxation.
Investment benefits
Special provisions for specific investments
Some investments have unique features that help you navigate inflation.
For instance, investments in certain bonds issued by the government or infrastructure companies come with perks like tax-free interest or benefits under Section 80CCF of the Income Tax Act.
These instruments are designed to incentivize long-term commitment while offering a buffer against inflation through higher interest rates or tax advantages.
Home loan relief
Deductions on home loans interest
For people taking home loans, Section 24(b) of the Income Tax Act permits deductions on interest paid on such loans up to ₹200,000 p.a.
This indirectly adjusts for inflation by providing relief on interest payments, which naturally increase with rising inflation rates over time.
It protects homeowners from being unduly disadvantaged by their loan repayments in real terms.
Allowance adjustments
Adjustment in allowances and benefits
Many allowances and benefits offered by employers are inherently designed to adjust for inflation through specific exemptions under the Income Tax Act.
For example, House Rent Allowance calculations take into account salary and rent paid, both of which naturally adjust for cost-of-living changes over time.
Likewise, Leave Travel Allowance exemptions motivate spending even when travel costs increase due to inflation.