Real income doctrine excludes NPA interest from accrual where prudential norms and CBDT guidance defer recognition.

Interest on non-performing assets of a co-operative bank was not taxable on accrual basis where the advances were doubtful and the income had not really arisen during the year. Because the bank was outside the special rule in section 43D, the issue was governed by general accrual principles, but the mercantile system alone did not create taxable income. The CBDT circular issued under section 119 and RBI prudential norms were treated as relevant to determining whether real income had accrued. Interest kept out of the profit and loss account and carried in the balance sheet was therefore treated as not having accrued, and the addition was deleted.

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Issues: Whether interest on non-performing assets or sticky advances of a co-operative bank was taxable on accrual basis, and whether the assessee could rely on RBI prudential norms and the CBDT circular to postpone recognition of such interest until actual realisation.

Analysis: The assessee was a co-operative bank not covered by the special treatment under section 43D, so the controversy turned on the general principle of income accrual. The Court followed the settled view that interest on doubtful or irrecoverable NPA advances does not accrue as real income merely because the assessee follows the mercantile system. It also relied on the binding nature of the CBDT circular issued under section 119 and the principle that prudential norms governing income recognition are relevant for determining whether any real income has arisen. Applying the jurisdictional and persuasive precedents cited before it, the Court held that the interest kept out of the profit and loss account and shown in the balance sheet did not accrue during the year.

Conclusion: The addition made on account of interest on NPAs on accrual basis was not sustainable and was rightly deleted, leaving the Revenue without relief.

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