Real income principle governs taxation of NPA interest; mere mercantile accounting does not automatically trigger accrual taxation.

Interest allegedly accrued on non-performing assets of an NBFC cannot be taxed merely because the assessee follows the mercantile system; the decisive enquiry is whether real income in fact accrued in light of collectibility and uncertainty of recovery. Applying Southern Technologies Ltd., the RBI prudential directions were treated as operating in a different field from the Income-tax Act, but the Assessing Officer had not examined whether the advances had become non-performing assets or whether interest was actually recognisable. The addition was therefore not finally sustainable on the existing findings, and the matter required reconsideration by the Assessing Officer under the real income principle.

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Issues: Whether interest claimed to have accrued on non-performing assets of an NBFC could be taxed on accrual basis merely because the assessee followed the mercantile system of accounting, and whether the matter required reconsideration by the Assessing Officer.

Analysis: The decision turned on the distinction between accrual and collectibility of income. The ruling in Southern Technologies Ltd. was applied to hold that the RBI prudential directions operate in a different field from the Income-tax Act, but that in each case the assessee must establish that interest was not recognised because of uncertainty in collection. The Assessing Officer had proceeded only on the mercantile system without examining whether the advances had in fact become non-performing assets and whether any real income had accrued. The proper enquiry was therefore whether the theory of real income displaced accrual in the facts of the case.

Conclusion: The addition could not be finally sustained on the existing findings, and the matter had to be re-examined by the Assessing Officer in light of the real income principle and the Supreme Court dicta.

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