Real income principle bars tax on notional NPA interest where recovery is doubtful and accrual has not occurred.

Interest on non-performing assets of a co-operative bank was held not to accrue for tax purposes where recovery was doubtful and the amount had not been credited to the profit and loss account. The Tribunal applied the real income principle, noting that mercantile accounting did not by itself create taxable accrual when the advances had been classified as NPAs under RBI prudential norms. Section 43D was held not to govern the matter in the manner argued by the Revenue, and the addition based on notional interest was found unsustainable.

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Issues: Whether notional interest on non-performing assets of a co-operative bank could be brought to tax on accrual basis.

Analysis: The issue turned on whether the assessee's interest from NPAs had really accrued during the relevant years. The Tribunal noted that the assessee, though following the mercantile system, had not credited such interest to the profit and loss account and had treated the advances as NPAs under RBI prudential norms. It held that section 43D did not govern the assessee in the manner suggested by the Revenue, but the broader question of accrual had to be decided on real income principles and on the factual improbability of recovery. Relying on the binding line of decisions favouring the assessee, the Tribunal concluded that mere classification of an account as NPA did not by itself establish accrual of interest income where recovery remained doubtful.

Conclusion: The notional interest on NPAs could not be assessed as income on accrual basis, and the addition was unsustainable.

Ratio Decidendi: Interest on NPAs is not taxable on accrual basis where, on the facts, recovery is doubtful and the income has not really accrued.

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