Real income principle protects co-operative banks from tax on unrealised NPA interest under RBI and CBDT norms.

Interest on non-performing assets of a co-operative bank is governed by the real income principle and the binding RBI/CBDT framework, so notional interest on sticky advances transferred to suspense account is not taxable merely because the bank follows the mercantile system. The jurisdictional High Court authorities treated co-operative banks as subject to RBI income-recognition norms and accepted that CBDT circulars bind the department; the non-banking finance company context was distinguished. On that basis, interest was taxable only on actual realisation, and the addition for NPA interest was held unsustainable.

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Issues: Whether interest on non-performing assets in the hands of a co-operative bank was taxable on accrual basis, or whether RBI prudential norms and binding CBDT instructions required exclusion of such notional interest until actual receipt.

Analysis: The assessee was a co-operative bank following RBI prudential norms for income recognition on NPAs. The Revenue relied on the proposition that RBI directions cannot override the Income-tax Act and that mercantile accounting required accrual taxation. The decision was governed by the jurisdictional High Court's ruling that co-operative banks are also subject to RBI directions, that the principle of real income applies to sticky advances, and that the CBDT circulars issued under the Act are binding on the department. The High Court authorities distinguished the non-banking finance company context and held that interest on doubtful or sticky advances transferred to suspense account is not to be brought to tax until actually realised where the applicable conditions are met.

Conclusion: The addition on account of interest on NPAs was not sustainable, and the deletion made in appeal was upheld.

Ratio Decidendi: In the case of a co-operative bank, interest on sticky NPA advances is governed by the real income principle and the binding RBI/CBDT framework, so notional interest not actually realised is not taxable merely because the assessee follows the mercantile system.

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