Real income principle governs NPA interest, while audit fees, NPA provisions, and limited TDS verification were upheld.

Unrealised interest on non-performing assets was treated as non-taxable on accrual where recovery was doubtful, applying the real income principle despite mercantile accounting, and a limited direction to verify the quantum was held within appellate jurisdiction. The provision for NPAs was accepted as a deduction as a provision for bad and doubtful debts made in line with RBI prudential norms. Audit fees were allowed on accrual because the liability had crystallised under the service rules. A verification direction on TDS for building rent under section 40(a)(ia) was also treated as within jurisdiction because it only checked for prior payment and avoided double disallowance.

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Issues: (i) Whether interest on non-performing assets was taxable on accrual basis or on receipt basis and whether the direction to verify the quantum of interest exceeded the appellate authority's powers; (ii) Whether the provision for non-performing assets was allowable as a deduction; (iii) Whether the provision for audit fees was allowable on accrual basis; (iv) Whether the direction to verify TDS payments in relation to building rent under section 40(a)(ia) was beyond the appellate authority's powers.

Issue (i): Whether interest on non-performing assets was taxable on accrual basis or on receipt basis and whether the direction to verify the quantum of interest exceeded the appellate authority's powers.

Analysis: The dispute concerned interest on loans classified as NPAs, where recovery was doubtful. The applicable principle was that unrealised income from NPAs does not represent real income merely because the assessee follows mercantile accounting. The appellate authority had also directed only a factual re-computation of the correct quantum after verifying the books and opening and closing balances, which was not a fresh adjudication on the substantive issue.

Conclusion: The interest on NPAs was rightly excluded from accrual taxation on the facts of the case, and the limited direction for recomputation was within jurisdiction, in favour of the assessee.

Issue (ii): Whether the provision for non-performing assets was allowable as a deduction.

Analysis: The provision was treated in substance as a provision for bad and doubtful debts and was made in accordance with RBI prudential norms. The governing provision permitted deduction for such a provision, and the record did not justify interference with the appellate finding granting the claim.

Conclusion: The deduction for provision for NPAs was allowable, in favour of the assessee.

Issue (iii): Whether the provision for audit fees was allowable on accrual basis.

Analysis: The liability for audit fees had crystallised under the applicable service rules and the assessee followed mercantile accounting. Once the liability became definite, deduction could not be denied merely because payment was made later.

Conclusion: The provision for audit fees was allowable, in favour of the assessee.

Issue (iv): Whether the direction to verify TDS payments in relation to building rent under section 40(a)(ia) was beyond the appellate authority's powers.

Analysis: The appellate direction was confined to verification of the assessee's claim that TDS on building rent had already been paid and to avoid double disallowance. It did not amount to a wholesale remand for fresh adjudication of the disallowance under section 40(a)(ia).

Conclusion: The direction was within jurisdiction and the disallowance was not restored, in favour of the assessee.

Final Conclusion: The Revenue's challenge to the relief granted by the first appellate authority failed on all material issues, and the assessment additions/disallowances did not survive.

Ratio Decidendi: Income from NPAs is not assessable on a merely notional accrual basis where recovery is doubtful and the issue is governed by the real income principle, while a limited factual verification by the appellate authority to quantify relief does not exceed its powers.

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