Indexation is a technique to adjust tax payments by employing a price index which adjusts for inflation. Or, in other words, indexation is the process that takes into account inflation from the time you bought the asset to the time you sell it.
The way it works is that it allows you to inflate the purchase price of the asset to take into account the impact of inflation. The end result is that you get the benefit of lowering your tax liability.
Taxpayers can use the benefit of the indexation for computing the capital gains arising on the sale of long-term capital assets only. Indexation benefit cannot be used for computing capital gains arising on sale of Short-term capital asset.