RBI prudential norms stop NPA interest accrual, while pigmy commission disallowance needs fresh examination.

Interest on non-performing asset advances to a co-operative bank was treated as not accruing for tax when RBI prudential norms governed income recognition and recovery remained doubtful, so the addition was deleted. On pigmy commission, the Tribunal held that the assessee's reliance on the second proviso to section 40(a)(ia) and section 201(1) had not been examined by the lower authorities, so the disallowance matter was remanded to the Assessing Officer for fresh consideration after hearing the assessee. The appeal was thus partly allowed.

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Issues: (i) Whether interest income relatable to non-performing assets accrued to a co-operative bank following RBI prudential norms and was taxable on accrual basis; (ii) Whether disallowance under section 40(a)(ia) for non-deduction of tax on pigmy commission required fresh examination in light of the second proviso to section 40(a)(ia) and section 201(1).

Issue (i): Whether interest income relatable to non-performing assets accrued to a co-operative bank following RBI prudential norms and was taxable on accrual basis.

Analysis: The Tribunal noted that the assessee, though maintaining accounts on mercantile basis, was governed by RBI prudential norms for income recognition. It followed earlier co-ordinate Bench reasoning that interest on NPA advances does not represent accrued income where recovery itself is doubtful. The Tribunal also relied on the view that, for income recognition, RBI directions have overriding effect under section 45Q of the Reserve Bank of India Act, 1934, and preferred the view favourable to the assessee in the presence of contrary non-jurisdictional High Court decisions.

Conclusion: The addition for interest on NPAs was deleted and the issue was decided in favour of the assessee.

Issue (ii): Whether disallowance under section 40(a)(ia) for non-deduction of tax on pigmy commission required fresh examination in light of the second proviso to section 40(a)(ia) and section 201(1).

Analysis: The Tribunal held that the plea based on the second proviso to section 40(a)(ia) was raised for the first time before it and had not been examined by the lower authorities. Following a co-ordinate Bench decision, it restored the matter to the Assessing Officer for fresh consideration in accordance with law after giving the assessee an opportunity of hearing.

Conclusion: The disallowance issue was remanded for fresh adjudication.

Final Conclusion: The assessee succeeded on the NPA interest issue, while the pigmy commission disallowance issue was sent back for reconsideration, leaving the appeal only partly allowed.

Ratio Decidendi: Interest on NPA advances does not accrue for taxation where, applying RBI prudential norms and the real income concept, recovery remains doubtful and income recognition is postponed.

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