InvestorQ : How does inflation get into the picture when calculating capital gains tax? # How does inflation get into the picture when calculating capital gains tax? Answer 1 year ago

Inflation is a term that most of us are familiar with. It is the general rise in the price levels and makes life more expensive and therefore more difficult. Inflation is popularly known as the thief of purchasing as it reduces your purchasing power over a period of time. For example, Rs.100 today is worth less than that if inflation is positive. According to the CPI numbers put by the Ministry of Statistics and Program Implementation (MOSPI) each month, the current rate of inflation is around ranging between 4 to 5% per annum. It means the cost of living will go up to that extend approximately. Here is how the cost of living will look like for next 5 years if you assume that inflation is 5%.

 Monthly Expense Today At the end of Year 1 At the end of Year 2 At the end of Year 3 At the end of Year 4 At the end of Year 5 Rs.10,000 Rs.10,500 Rs.11,025 Rs.11,576 Rs.12,155 Rs.12,763

How do we read the above table? Inflation reduces the value of money. From the above table we can infer that if you are spending Rs.10,000 each month then you need to spend at least Rs.12,763 each month after 5 years to maintain the same standard of living. That is because costs are going up. You can also look at this in another way. If someone is committing to pay you Rs.12,155 at the end of 4 years then that is just worth Rs.10,000 in today’s value. You need to negotiate inflows accordingly after consider the impact of inflation. That is called the time value of money and is determined by the rate of inflation, which indirectly determines the rate of interest.

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