What is indexation?

What is indexation?

• A. Indexation applies to deductions from revenue expenses
• B. Indexation applies to inflation-adjusted capital gains on disposal
• C. Indexation reduces the base cost of an asset automatically
• D. Indexation applies to depreciation allowances only

Answer: (B)

Indexation means adjusting the cost base of an asset to reflect inflation when calculating capital gains on disposal. By inflating the original purchase cost to match price increases over the holding period, the gain that is taxed becomes smaller. This is why the correct interpretation is that indexation applies to inflation-adjusted capital gains on disposal. For example, if you bought an asset for 10,000 and inflationing over the period increases the cost base to 12,000, selling at 18,000 gives a nominal gain of 8,000 but an indexed gain of 6,000, reducing the taxable amount. It does not relate to deductions from revenue expenses, nor to depreciation allowances, and it doesn’t automatically reduce the base cost in the way implied by those other statements.

Indexation means adjusting the cost base of an asset to reflect inflation when calculating capital gains on disposal. By inflating the original purchase cost to match price increases over the holding period, the gain that is taxed becomes smaller. This is why the correct interpretation is that indexation applies to inflation-adjusted capital gains on disposal. For example, if you bought an asset for 10,000 and inflationing over the period increases the cost base to 12,000, selling at 18,000 gives a nominal gain of 8,000 but an indexed gain of 6,000, reducing the taxable amount. It does not relate to deductions from revenue expenses, nor to depreciation allowances, and it doesn’t automatically reduce the base cost in the way implied by those other statements.