Income from non-performing assets taxable only when actually received, not on accrual; s.36(1)(viii) reserve deduction upheld

HC held for the assessee that income from non-performing assets should be recognized on a cash basis (only when actually received) rather than merely on accrual, despite the assessee following the mercantile system, and that such treatment aligns with policy guidelines and prior HC authority allowing reserve deductions under s.36(1)(viii) for financial corporations. The Court noted that accounting method compliance is subject to Central Government directions on accounting standards but affirmed that NPAs cease to yield income and may be taxed only upon receipt, deciding in favor of the assessee.

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Issues:
1. Assessment of interest and dividend income under the head "Business income" and deduction under section 36(1)(viii) of the Act.
2. Assessment of income from non-performing assets on cash basis vs. mercantile basis.

Analysis:

Issue 1:
The Court referred to a previous case involving the same assessee, where it was held that a special reserve created by a financial corporation should be deducted from the taxable income under the heading 'Profits and gains'. The Court emphasized that no deduction should be made under specific clauses and chapters before computing the total income. Therefore, the Court concluded that interest and dividend income should not be assessed under "Business income" but under "Income from other sources," allowing the deduction under section 36(1)(viii) of the Act in favor of the assessee.

Issue 2:
Regarding the assessment of income from non-performing assets, the revenue contended that under section 145(2) of the Income-tax Act, income accrued from such assets, regardless of actual receipt, should be considered for tax payment if the assessee follows the mercantile system of accounting. The Court analyzed section 145, highlighting that compliance with cash or mercantile accounting systems is subject to accounting standards notified by the Central Government. The Court also referred to accounting standards emphasizing the recognition of income based on accrual and the guidelines issued by the National Housing Bank on non-performing assets. The Court cited precedents where the concept of real income was discussed, concluding that income from non-performing assets should only be recognized when actually received. Therefore, the Court ruled in favor of the assessee, stating that the revenue's contention to tax notionally accrued income from non-performing assets under the mercantile system was unfounded.

In conclusion, the Court dismissed the appeal based on the detailed analysis and rulings on both substantial questions of law, affirming the decisions in favor of the assessee on both issues.

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