Real income principle and banking deductions: NPA interest, broken period interest, bond premium amortisation, and provident fund relief

Interest on non-performing assets was treated as not accruing on a real income basis where a non-scheduled co-operative bank followed RBI prudential norms and did not credit such interest, so taxation on mercantile accrual was rejected. Broken period interest paid on purchase of government securities was regarded as a revenue-linked banking expenditure and allowed as deduction. Amortisation of premium on held-to-maturity securities was permitted in line with banking practice and RBI norms, and employees' provident fund contribution deposited before the return filing due date was allowed as a deduction despite late payment under the provident fund law.

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Issues: (i) Whether interest income on non-performing assets was taxable on accrual basis in the case of a non-scheduled co-operative bank not covered by section 43D; (ii) whether broken period interest paid on purchase of government securities was allowable as deduction; (iii) whether amortization of premium paid on held to maturity securities and employees' contribution to provident fund deposited before the due date of filing of return were allowable deductions.

Issue (i): Whether interest income on non-performing assets was taxable on accrual basis in the case of a non-scheduled co-operative bank not covered by section 43D.

Analysis: The bank followed RBI prudential norms and did not credit interest on NPAs to its profit and loss account. The question was whether such interest could still be brought to tax on mercantile accrual principles. The Tribunal followed its earlier view in similar matters and applied the principle that, where two non-jurisdictional High Court views exist, the view favourable to the assessee may be adopted. It relied on the Delhi High Court view that interest on NPAs does not accrue as real income until receipt, and distinguished the contrary Madras High Court view. Section 43D was held inapplicable to the assessee, but that did not make the income taxable on accrual if no real accrual had taken place.

Conclusion: The interest on NPAs was not taxable on accrual basis and the deletion of the addition was upheld in favour of the assessee.

Issue (ii): Whether broken period interest paid on purchase of government securities was allowable as deduction.

Analysis: The assessee purchased securities from the secondary market and paid the seller the interest relatable to the period before purchase. The Tribunal noted the Bombay High Court view that such broken period interest is deductible, after considering the conflicting authorities relied upon by the lower authorities. The payment was treated as a revenue item connected with the banking business rather than a capital outlay.

Conclusion: The broken period interest was allowable as deduction and the disallowance was deleted in favour of the assessee.

Issue (iii): Whether amortization of premium paid on held to maturity securities and employees' contribution to provident fund deposited before the due date of filing of return were allowable deductions.

Analysis: For held to maturity securities, the Tribunal followed the Bombay High Court view that the premium written off over the remaining maturity period is allowable in accordance with banking practice and RBI norms. For employees' contribution to provident fund, the Tribunal applied the jurisdictional High Court ruling that such contribution, if deposited before the due date of filing the return, is allowable and not hit by disallowance merely because it was paid after the statutory due date under the provident fund law.

Conclusion: Both the amortization claim and the provident fund deduction were allowed in favour of the assessee.

Final Conclusion: The Revenue's appeals failed on the NPAs issue, while the assessee succeeded on the connected cross-objections relating to broken period interest, amortization of premium on held to maturity securities, and employees' provident fund contribution, resulting in overall relief to the assessee.

Ratio Decidendi: Interest on NPAs does not accrue as taxable income where, applying RBI prudential norms and the real income principle, recovery is doubtful and the interest is not credited or received; banking-related deductions governed by binding jurisdictional precedent are allowable according to the applicable accounting and tax principles.

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