RBI prudential norms govern NPA interest recognition, while TDS disallowance applies to both paid and payable amounts.

Interest on non-performing assets of a co-operative bank was not taxable on accrual where RBI prudential norms governed income recognition; by applying section 45Q of the Reserve Bank of India Act, the Tribunal treated such interest as accruing only on actual receipt and deleted the addition. For TDS default, payments for computerisation made without deduction under section 194C attracted disallowance under section 40(a)(ia), because the Supreme Court's interpretation in Palam Gas Service covers both amounts paid and amounts payable; the disallowance was upheld.

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Issues: (i) Whether provision for overdue interest relating to non-performing assets could be treated as taxable income on accrual basis when income recognition was governed by RBI prudential norms. (ii) Whether disallowance under section 40(a)(ia) was sustainable for payments made without deduction of tax at source under section 194C.

Issue (i): Whether provision for overdue interest relating to non-performing assets could be treated as taxable income on accrual basis when income recognition was governed by RBI prudential norms.

Analysis: The assessee was a co-operative bank governed by RBI directions on income recognition. Interest on non-performing assets was not recognised on accrual basis under those prudential norms and was brought to tax only on actual receipt. The Tribunal followed the settled principle that, for income recognition, RBI directions prevail by virtue of section 45Q of the Reserve Bank of India Act, 1934, and that such interest on NPA does not accrue as real income merely because it is entered in the books.

Conclusion: The addition for overdue interest was rightly deleted and the issue was decided in favour of the assessee.

Issue (ii): Whether disallowance under section 40(a)(ia) was sustainable for payments made without deduction of tax at source under section 194C.

Analysis: The assessee had made payments for computerisation without deducting tax at source. The Tribunal noted that the earlier view based on Merilyn Shipping no longer governed the field and that the Supreme Court in Palam Gas Service held that the word "payable" in section 40(a)(ia) covers both amounts outstanding and amounts already paid. On that footing, the statutory disallowance applied.

Conclusion: The disallowance under section 40(a)(ia) was upheld and the issue was decided in favour of the Revenue.

Final Conclusion: The appeal of the Revenue succeeded only on the TDS disallowance issue, while the assessee succeeded on the overdue interest issue, resulting in a partial allowance of both the appeal and the cross objection.

Ratio Decidendi: For co-operative banks, income from non-performing assets is recognised only on actual receipt in accordance with RBI prudential norms, but section 40(a)(ia) applies to both paid and payable amounts where tax was required to be deducted at source.

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