Real income principle excludes NPA interest from accrual taxation where principal recovery remains doubtful under RBI norms.

Interest on non-performing assets was held not taxable on accrual basis where the cooperative bank, applying RBI prudential income-recognition norms, had not credited the interest as income and recovery of the principal remained doubtful. The Tribunal treated section 43D as inapplicable because the assessee was not a specified entity, but applied the real income principle and section 45Q of the RBI Act to conclude that mercantile accounting could not create accrual of unrealised interest. It distinguished Southern Technologies as dealing with provisioning deductions, and followed Vasisth Chay Vyapar to support exclusion of such interest from total income.

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Issues: Whether interest income relatable to non-performing assets was taxable on accrual basis in the hands of a cooperative bank following Reserve Bank of India prudential norms.

Analysis: The assessee bank did not credit interest on NPA advances as income, following RBI income-recognition norms. The statutory exemption under section 80P had ceased for the relevant year, but the core question remained whether the impugned interest had actually accrued. The Tribunal distinguished section 43D, noting that the assessee was not among the specified entities covered by that provision, and examined the broader principle of income recognition. Relying on the effect of section 45Q of the Reserve Bank of India Act, 1934 and the concept of real income, the Tribunal held that where recovery of the principal itself is doubtful, interest on such assets cannot be treated as accrued merely because the assessee follows mercantile accounting. It further accepted the view that the Supreme Court decision in Southern Technologies dealt with deductibility of provisioning, not taxation of unrealised NPA interest, and that the Delhi High Court decision in Vasisth Chay Vyapar directly supported the assessee's case.

Conclusion: The interest income relatable to NPA advances did not accrue to the assessee and was not includible in its total income.

Final Conclusion: The revenue's challenge to deletion of the addition failed, and the assessee obtained relief on the substantive taxability of unrealised NPA interest.

Ratio Decidendi: Interest on non-performing assets is not taxable on accrual basis where, applying RBI prudential norms and the real income theory, recovery of the principal itself is doubtful and the income has not in fact accrued.

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