RBI prudential norms override accrual taxation for NPA interest, so co-operative banks are taxed only on actual receipt.

Interest on non-performing assets in the hands of a co-operative bank was held not to be taxable on accrual basis where RBI prudential norms prohibit income recognition until receipt. The HC applied the real income principle, noted that Section 45Q of the Reserve Bank of India Act gives overriding effect to RBI directions on income recognition, and distinguished income recognition from computation of taxable income. It also considered Section 43D of the Income-tax Act and Rule 6EA, but held that the assessee could not be taxed on hypothetical accrued interest merely because it followed the mercantile system. Taxability arose only on actual receipt.

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Issues: Whether interest on non-performing assets in the hands of a co-operative bank is taxable on accrual basis or only on receipt basis having regard to the RBI prudential norms and the overriding effect of the Reserve Bank of India Act, 1934.

Analysis: Section 43D of the Income-tax Act, 1961 was examined along with the scheme of Rule 6EA of the Income-tax Rules, 1962 and the RBI provisions in Chapter III-B of the Reserve Bank of India Act, 1934. The Court noted that Section 45Q of the Reserve Bank of India Act, 1934 gives overriding effect to RBI directions on income recognition, and that RBI prudential norms require interest on NPAs not to be recognised on accrual basis. The Court further relied on the real income principle and the distinction between income recognition and computation of taxable income. It held that the assessee, being bound by RBI guidelines, could not be taxed on hypothetical accrued interest on NPAs merely because it follows the mercantile system of accounting. The Court also held that the restrictive scope of the pre-amendment Section 43D did not alter the position where income had not in reality accrued.

Conclusion: Interest on NPAs in the hands of the assessee co-operative bank was not taxable on accrual basis and was taxable only when actually received.

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