Real income doctrine governs NPA interest taxation; RBI prudential norms can control income recognition over mere accrual.

Interest on non-performing assets was held not taxable on mere mercantile accrual where, under RBI prudential norms, no real income had arisen. The court applied the principle in Vasisth Chay Vyapar Ltd. that prudential norms do not override the Act for deductions or exclusions, but they do govern income recognition for NPAs, including for NBFCs. On that basis, the assessee could recognise such interest on receipt basis despite section 145 of the Income-tax Act, and the Revenue's challenge failed.

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Issues: Whether interest accrued on non-performing assets was taxable on accrual basis, and whether the assessee could recognise such interest on receipt basis in view of RBI prudential norms notwithstanding Section 145 of the Income-tax Act, 1961.

Analysis: The issue was governed by the principle laid down by the Supreme Court in Vasisth Chay Vyapar Ltd., which held that though prudential norms do not override the computation provisions of the Income-tax Act for deductions or exclusions, they do govern income recognition in the case of non-performing assets. The decision distinguished between taxability of real income and mere notional accrual, and recognised that RBI directions concerning income recognition apply to NBFCs in the relevant field. On that basis, interest on NPAs cannot be brought to tax merely on mercantile accrual when, in substance, no real income has arisen.

Conclusion: The question was answered against the Revenue and in favour of the assessee.

Final Conclusion: The appeals failed and were dismissed, as the disputed interest on NPAs was held not taxable on accrual basis in the facts of the case.

Ratio Decidendi: For income-recognition purposes, RBI prudential norms governing NPAs prevail over mercantile accrual, and only real income can be taxed.

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