1) The policy of connecting such economic variables as wages, taxes, social-security payments, annuities, or pensions to rises in the general price level (see inflation). This policy is often advocated by economists in the belief that it mitigates the effects of inflation. In practice, complete indexation is rarely possible, so that inflation usually leaves somebody worse off (e.g. lenders, savers) and somebody better off (borrowers).
2) The practice of adjusting the chargeable gain from the sale of an asset to take account of inflation over the period of ownership of the asset. In the UK corporation tax system an indexation factor derived from the rise in the Retail Price Index during the period of ownership is applied to the cost, or 31 March 1982 value, of an asset. The indexed cost or value is then deducted from the proceeds of sale on disposal of the asset, in order to establish the chargeable gain. Indexation was formerly also applied to gains chargeable to capital gains tax, but in such cases it has been replaced by taper relief from 6 April 1998. However, for assets acquired before that date, the indexation allowance is calculated to 5 April 1998 and this figure is used to calculate the chargeable gain in any subsequent disposal.

Accounting dictionary. 2014.

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