NPA interest does not accrue as taxable income when RBI directions and the real income principle prevent accrual.

Interest on non-performing assets of a co-operative bank is not treated as taxable accrual income where, in accordance with RBI directions, the asset has been classified as non-performing and the real income has not arisen. The mercantile system does not override the RBI-prescribed treatment, because the RBI framework has overriding effect under section 45Q of the Reserve Bank of India Act, 1934. The note also reflects that the assessee's method was consistent with accounting standards and that the judicial view relied upon supported non-accrual of such interest. On that basis, the NPA interest addition was deleted.

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Issues: Whether interest on non-performing assets of a co-operative bank was taxable on accrual basis under the mercantile system of accounting notwithstanding RBI guidelines, and whether the addition made on that account was sustainable.

Analysis: The assessee followed the mercantile system generally, but in respect of interest on NPAs it adopted the RBI-prescribed method, which also accorded with the accounting standards. Section 45Q of the Reserve Bank of India Act, 1934 gives overriding effect to the RBI regime. The interest on NPAs, once the asset was classified as non-performing in accordance with RBI directions, was treated as not having accrued on the basis of the real income principle. The judicial view relied upon by the assessee supported this position, and the Revenue's authorities were distinguished. The record also showed that the assessee was treated as a scheduled bank, supporting the applicability of the statutory framework invoked by the assessee.

Conclusion: The addition made towards accrued interest on NPAs was not sustainable and was rightly deleted; the issue was decided in favour of the assessee.

Final Conclusion: The departmental appeals failed on the common issue and the orders deleting the NPA interest addition were upheld.

Ratio Decidendi: Interest on NPAs does not accrue as taxable income where, in accordance with RBI directions, the asset is classified as non-performing and the real income has not arisen, even though the assessee follows the mercantile system of accounting.

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