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Monday, October 08, 2012

Difference between Financial Year and Assessment Year

Sometimes, things as simple as the difference between the Financial Year (FY) and an Assessment Year(AY) can give you the right perspective to look at things.

We studied in detail about the Financial Year / Fiscal Year, its origin and relevance in different countries and continents across the globe in one of our earlier posts ( What is Financial or Fiscal Year ). Today, let us try and understand how this Financial Year is different from an Assessment Year.

Let us just summarize what we understood about Financial Year or Fiscal Year:
A Fiscal Year (or a Financial Year or Accounting Reference Date) is a 12-month period used for calculating annual ("yearly") financial reports in businesses and other organizations. In many jurisdictions, regulatory laws regarding accounting require such reports once per twelve months, but do not require that the twelve months constitute a calendar year (i.e. January to December).

The income earned in a year is always assessed and taxed in the next year. The year in which income is earned is called the Financial Year and the year in which this income is assessed (for accuracy etc.) and taxed is called the Assessment Year.

As an example, the income of Financial Year 2011-12 will be assessed for the taxes to be paid and will be taxed in Assessment Year 2012-13.

So, the entire concept is to earn income in a particular year and pay tax on it and file your Income Tax Return (ITR) in the next year . Also remember that all tax laws are framed for Assessment Year and not for the Financial Year i.e. reference to any year in Tax laws will means reference to the Assessment Year. 

If the current date is 20th April 2016, then we are in the Financial Year 2016-17 and Assessment Year 2017-18. This means that we will be earning our income in the year 2016-17 (1st April 2016 to 31st March 2017) and we will be paying taxes on this income in the Assessment Year 2017-18 (1st April 2017 to 31st March 2018).

Some of you who work as employees might get confused with what i just said. Hold on, there are exceptions to the above rule, and your salary income happens to be one of the exceptions. In general, the above rules apply to all incomes except certain specific incomes like salaried income where the tax is paid even before the income touches your hand. Such tax deduction is called as Tax Deduction at Source (TDS). There is also a concept of higher income groups and  businesses paying Advance Tax. In these exceptional cases, you pay tax in the same year as the financial year i.e. the year in which you earned the money.

However, even in these cases, remember that the Income Tax returns are filed in the Assessment Year only. So, if you have a source of income other than your salary (salary gets tax deducted at source) like bank FD interests, capital gains through stocks, mutual funds and property etc, then in all such cases, you would be declaring this income only in the Assessment Year and also paying taxes in the Assessment Year only.

In nutshell, an Assessment Year allows you some freedom of time to assess your correct tax liability to be paid to the government for the money that you earned in the Financial Year.

As you approach towards Financial Freedom, your portfolio would mostly consist of income which is passive in nature i.e. it does not come by working actively for your salary every year. Your nest egg would be giving you most of the returns. Most of the income for a financially free person comes from interests and capital gains, and hence, the tax is mostly paid in the Assessment Year. :)

Like the article? 
Do not hesitate to share. It can make a positive impact on someone's life.

The book "From the Rat Race to Financial Freedom" has many such investment concepts explained in a very simple and uncomplicated manner, especially in the Indian context.


Manoj Arora
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