RBI income recognition rules bar accrual tax on NPA interest for a co-operative bank

For a co-operative bank treated as a banking company, RBI directions on asset classification and income recognition govern the treatment of interest on non-performing assets. Where those directions bar recognition of such interest on accrual basis, the mercantile method under the Income-tax Act does not require taxation of unrealised interest. On that basis, interest on NPAs was not taxable on accrual basis and the related addition was deleted.

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Issues: Whether interest on non-performing assets of a co-operative bank was taxable on accrual basis despite RBI norms governing income recognition.

Analysis: The dispute turned on the interaction between income recognition under the Income-tax Act and the regulatory framework applicable to banking entities. The decision followed the binding view that, for a co-operative bank treated as a banking company under the banking law, RBI directions governing asset classification and income recognition prevail by virtue of the overriding effect of the Reserve Bank of India Act. Where such directions prohibit recognition of interest on NPAs on accrual basis, the mercantile method under the Income-tax Act does not compel taxation of unrealised interest.

Conclusion: Interest on NPAs was not taxable on accrual basis in the hands of the assessee, and the addition was rightly deleted.

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