Taxability of NPA interest follows real income and RBI recognition norms, not mere accrual in a co-operative bank's hands.

Interest on non-performing assets in a co-operative bank was treated as taxable only when actually received, because RBI prudential norms on income recognition governed the timing of recognition even though the assessee followed the mercantile system. The distinction between income recognition and tax computation was material: the Income-tax Act governed computation of taxable income, but the RBI framework determined when interest on NPAs could be recognised as income. The principle of real income, rather than hypothetical accrual, applied where collection was uncertain. On that basis, interest on NPAs was not taxable on accrual basis in the assessee's hands.

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Issues: Whether interest on non-performing assets is taxable on accrual basis in the hands of a co-operative bank when the Reserve Bank of India income-recognition norms require such interest to be recognised only on actual receipt.

Analysis: The assessee, though following the mercantile system, was bound by the Reserve Bank of India prudential norms governing income recognition for non-performing assets. The statutory scheme treated those norms as overriding for the purpose of income recognition, so that interest on such assets could not be brought to tax merely on a notional accrual basis. The distinction between income recognition and computation of taxable income was material: while the Income-tax Act governs computation, the Reserve Bank of India framework governs the point at which income from non-performing assets is recognised. The Court also accepted the principle that real income, and not hypothetical income, is the proper basis where collection itself is uncertain.

Conclusion: Interest on non-performing assets was not taxable on accrual basis in the assessee's hands; the issue was decided in favour of the assessee and against the Revenue.

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