NPA income recognition and gratuity fund deduction: RBI norms govern receipt basis taxation, and actual employee-benefit payments may qualify

For a co-operative bank, interest on non-performing assets is recognised only on actual receipt basis where RBI prudential norms prevail over accrual accounting by virtue of section 45Q of the RBI Act, so such income is not brought to tax on accrual. Actual payment to an LIC group gratuity fund was treated as real expenditure for the exclusive benefit of employees, not a mere provision, so the deduction was allowable and the restrictions in sections 36(1)(v) and 40A(7) did not apply on these facts.

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Issues: (i) Whether interest on non-performing assets of a co-operative bank was taxable on accrual basis or only on actual receipt basis; (ii) Whether actual payment made to the LIC group gratuity fund was allowable as a deduction.

Issue (i): Whether interest on non-performing assets of a co-operative bank was taxable on accrual basis or only on actual receipt basis.

Analysis: The applicable legal position was that, for income recognition by a co-operative bank, the RBI directions prevail by virtue of the overriding effect of section 45Q of the Reserve Bank of India Act, 1934. Income from non-performing assets is not to be recognised on accrual basis and can be brought to tax only when actually received. The computation provisions of the Income-tax Act remain separate, but at the stage of income recognition the Assessing Officer must follow the RBI prudential norms.

Conclusion: Interest on NPAs was not taxable on accrual basis and was to be recognised only on actual receipt basis, in favour of the assessee.

Issue (ii): Whether actual payment made to the LIC group gratuity fund was allowable as a deduction.

Analysis: The payment was made towards an irrevocable gratuity arrangement for the exclusive benefit of employees and was treated as actual expenditure, not a mere provision. The disallowance under section 36(1)(v) and section 40A(7) did not survive on the facts, and the payment was held allowable as business deduction.

Conclusion: The gratuity payment made to LIC was allowable as a deduction, in favour of the assessee.

Final Conclusion: The revenue's appeals failed on both substantive issues, while the assessee obtained relief on the merits; the cross objections were dismissed for being out of time.

Ratio Decidendi: In the case of a co-operative bank, income from non-performing assets is recognised only on actual receipt where RBI directions apply with overriding force, and actual payment towards an employee gratuity arrangement may be allowed as a deduction when it is not a mere provision.

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