Interest on non-performing assets does not accrue for tax when RBI directions bar recognition under mercantile accounting.

Interest on non-performing assets was treated as not accruing for tax purposes where the co-operative bank followed mercantile accounting but, in accordance with binding RBI directions, did not recognise such income. The overriding effect of the RBI regime under section 45Q of the Reserve Bank of India Act, 1934, read with the treatment under section 43D of the Income-tax Act, supported the view that mere mercantile bookkeeping does not create taxable accrual when interest on NPAs is not recorded as income. On that basis, the addition was deleted and the Revenue's challenge failed.

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Issues: Whether interest on non-performing assets was taxable on accrual basis in the hands of a co-operative bank following mercantile accounting and RBI directions.

Analysis: The assessee was following the mercantile system of accounting subject to RBI guidelines for interest on NPAs. The material on record showed that the NPA-related amounts were reflected in the computation of total income and that the accounting treatment was in accordance with the RBI framework. Reliance was placed on the earlier decision in the assessee's own case, and the principle applied was that where an asset is classified as a non-performing asset in accordance with RBI directions, interest thereon cannot be treated as having accrued merely because mercantile accounting is otherwise followed. Section 45Q of the Reserve Bank of India Act, 1934 gives overriding effect to the RBI regime, and the assessee's case was also considered in the light of section 43D of the Income-tax Act, 1961.

Conclusion: The addition on account of interest on NPAs was not sustainable and was rightly deleted.

Final Conclusion: The Revenue's challenge failed and the assessment relief granted by the first appellate authority was maintained.

Ratio Decidendi: Interest on NPAs does not accrue for taxation purposes when, in accordance with binding RBI directions, such income is not recognized despite the assessee otherwise following the mercantile system of accounting.

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