Indexation is a financial mechanism used to adjust the value of an asset, income, or investment for the effects of inflation. The goal of indexation is to ensure that the real value of money remains consistent over time, preserving purchasing power and providing a more accurate reflection of true economic value. In India, indexation is most commonly applied in the context of capital gains taxation and certain government schemes.

When it comes to capital assets such as real estate, mutual funds, or bonds, indexation allows investors to adjust the purchase price of an asset based on inflation using the Cost Inflation Index (CII) published annually by the Government of India. This adjusted cost, known as the indexed cost of acquisition, helps reduce the taxable capital gain when the asset is sold.

The formula for calculating the indexed cost of acquisition is:

Indexed Cost = (Cost of Acquisition ? CII of Sale Year) / CII of Purchase Year

By applying indexation, investors pay taxes only on the real gain, not on the portion of profit that merely reflects inflation. For example, if you purchased a property for ?10 lakh several years ago and sold it for ?20 lakh, indexation would increase the original purchase cost to reflect inflation, thereby reducing your long-term capital gains (LTCG) tax liability.

Indexation is also used in wage adjustments, pension schemes, and government bonds to ensure that payments keep pace with rising prices. It plays an essential role in maintaining fairness in long-term financial planning by accounting for inflationís impact on value.

In summary, Indexation serves as a vital tool for inflation adjustment in taxation and financial calculations, helping investors and taxpayers maintain the real worth of their income and investments over time.