Sticky loan interest for an NBFC cannot be taxed on notional accrual when RBI norms require realizable income recognition.

Interest on sticky loans of a non-banking financial company was not taxable on accrual basis where RBI prudential norms required income recognition to follow realizable income and not merely mercantile accounting. Section 45Q of the Reserve Bank of India Act gave overriding effect to Chapter III-B, so the RBI's accounting treatment prevailed for an NBFC governed by those norms. Where assets had become non-performing and recovery of interest was uncertain, income could not be treated as truly accrued. In that situation, section 145 of the Income-tax Act could not be used to assess hypothetical income on notional accrual.

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Issues: Whether interest on sticky loans and advances of a non-banking financial company could be taxed on accrual basis despite reversal of income in accordance with Reserve Bank of India prudential norms.

Analysis: The decisive factor was that the assessee was a non-banking financial company governed by the Reserve Bank of India Act and the prudential norms issued thereunder. Section 45Q of the Reserve Bank of India Act gives overriding effect to Chapter III-B, and the accounting treatment mandated by the RBI norms required income recognition to be aligned with realizable income rather than notional accrual. The Tribunal followed the jurisdictional High Court's view that where the assets had become non-performing and recovery of interest was uncertain, interest could not be said to have truly accrued. In that situation, section 145 of the Income-tax Act could not be applied to tax hypothetical income on mere mercantile accrual.

Conclusion: The interest on sticky loans and advances was not taxable on accrual basis, and the revenue's challenge to deletion of the addition failed.

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