Real income principle defeats taxation of NPA interest for an NBFC where recovery remains uncertain.

An NBFC following RBI prudential norms was required to recognise revenue only where recovery was reasonably certain, and interest on an inter-corporate deposit classified as an NPA had remained unrealised for years with principal recovery itself doubtful. On those facts, the Court applied the real income principle and section 45Q of the RBI Act to hold that no taxable income had accrued. Southern Technologies was distinguished because it concerned deductibility of an NPA provision, not income recognition on these facts. The addition was therefore unsustainable and the revenue's appeals were dismissed.

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Issues: Whether interest on inter-corporate deposits classified as non-performing assets under the Reserve Bank of India directions could be treated as accrued income under the Income-tax Act, 1961.

Analysis: The assessee, a non-banking financial company, was bound by the statutory directions under the Reserve Bank of India Act, 1934 and the Prudential Norms requiring recognition of revenue only where ultimate collection was reasonably certain. The interest on the relevant deposit had remained unrealised for years, the principal itself had become doubtful of recovery, and the asset had been classified as an NPA. In these circumstances, the Court held that no real income had accrued. The decision in Southern Technologies was distinguished on the footing that it dealt with deductibility of a provision for NPA and not with the question of income recognition in the present facts. The non obstante effect of section 45Q of the RBI Act and the principle of real income supported the assessee's treatment.

Conclusion: Interest on the NPA did not accrue as taxable income, and the addition made by the Revenue was unsustainable.

Final Conclusion: The appeals failed and were dismissed, with the legal question answered in favour of the assessee.

Ratio Decidendi: Where an NBFC is statutorily required to follow RBI prudential norms and recovery of interest is uncertain on an NPA, such interest is not real accrued income for tax purposes despite mercantile accounting.

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