Real income principle bars accrual taxation of interest on non-performing assets under RBI prudential norms

Interest on non-performing asset advances of a co-operative bank was not taxable on accrual basis where section 43D did not apply and income recognition had to be tested on general accrual principles. Applying Reserve Bank of India prudential norms, reinforced by section 45Q of the Reserve Bank of India Act, 1934, the governing real income principle required that doubtful interest on a non-performing principal debt could not be treated as having truly accrued. Following the view favourable to the assessee amid conflicting non-jurisdictional High Court authorities, the addition was held unsustainable.

---

---

Issues: Whether interest income on non-performing asset advances of a co-operative bank, not covered by section 43D of the Income-tax Act, 1961, was taxable on accrual basis notwithstanding the Reserve Bank of India prudential norms.

Analysis: The dispute concerned addition of interest on non-performing assets in the hands of a co-operative bank following the mercantile system of accounting. Section 43D was held inapplicable to the assessee, so the issue fell to be decided on general principles of accrual. The governing principle applied was that, in view of the Reserve Bank of India prudential norms and the overriding effect of section 45Q of the Reserve Bank of India Act, 1934, income recognition must follow the real income principle. Where the principal debt itself had become doubtful, interest thereon could not be said to have truly accrued. Faced with divergent non-jurisdictional High Court views, the view favourable to the assessee was followed.

Conclusion: The interest on non-performing asset advances did not accrue as income during the relevant years and the addition was not sustainable.

Ratio Decidendi: Interest on non-performing assets is not taxable on accrual basis where, applying Reserve Bank of India prudential norms and the real income principle, no real accrual of income has taken place.

---