Real income principle governs NPA interest recognition for cooperative banks; accrual addition could not be sustained.

Interest on non-performing asset accounts of a cooperative bank was treated as taxable only on receipt basis where the assessee consistently followed RBI-guided accounting and recovery of principal was doubtful. Applying the real income principle, the text states that interest cannot be said to accrue when collectability is uncertain, and RBI directions have overriding effect for co-operative banks under section 45Q of the RBI Act, so section 145 of the Income-tax Act did not compel accrual recognition. The addition based on accrual was therefore not sustainable.

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Issues: Whether interest on non-performing assets was taxable on accrual basis or only on receipt basis in the hands of a cooperative bank following RBI directions.

Analysis: The assessee had consistently followed a policy of recognising interest on NPA accounts only on receipt basis in accordance with RBI guidelines and its accounting policy. The question was whether, despite the mercantile system of accounting, such interest could be treated as having accrued during the year. Applying the real income theory, the Court noted that where recovery of the principal itself is doubtful, interest cannot be said to have truly accrued. It relied on the line of authority holding that, for income recognition, RBI directions governing co-operative banks have overriding effect by virtue of section 45Q of the RBI Act, and that section 145 of the Income-tax Act does not compel accrual recognition in such cases. The decisions cited by the Revenue were distinguished or held not to govern the issue on the facts.

Conclusion: Interest on NPA accounts was rightly recognised on receipt basis, and the addition made on accrual basis was not sustainable.

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