Accrual of interest on NPAs: notional interest on doubtful loans was held not taxable under RBI income-recognition norms.

Interest on NPAs was held not taxable on accrual basis where a co-operative bank had not credited such interest to its profit and loss account in line with RBI prudential norms. The Tribunal applied the real income principle and noted that, when recovery of principal itself is doubtful, interest cannot be said to have truly accrued. It also accepted the binding effect of RBI directions on income recognition for sticky advances and the supporting view that notional interest on doubtful loans is not taxable. The Revenue's appeal failed and the disallowance was deleted.

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Issues: Whether interest on non-performing assets, not credited to the profit and loss account and treated as unrealizable under RBI norms, could be brought to tax on accrual basis in the hands of a co-operative bank.

Analysis: The addition was made on the premise that the assessee followed the mercantile system and that section 43D did not apply. The Tribunal noted that the assessee had not recognized the interest income in the profit and loss account in accordance with RBI prudential norms governing income recognition on NPAs. It relied on the principle that where recovery of the principal itself is doubtful, interest cannot be said to have truly accrued. The Tribunal also noted the binding effect of RBI directions and the supporting judicial view that notional interest on sticky or doubtful loans does not represent real income.

Conclusion: The interest on NPAs was not taxable on accrual basis and the disallowance was rightly deleted; the Revenue's appeal failed.

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