NPA interest accrual ruled non-taxable where recovery is uncertain and RBI prudential norms prevent recognition of notional income.

Overdue interest on non-performing assets was held not taxable on mere accrual where recovery remained uncertain and RBI prudential norms governed income recognition. Although the assessee cooperative bank followed the mercantile system, the Court applied the principle that RBI directions under the Reserve Bank of India Act override notional accrual for NPAs, so such interest does not become real income until actually received or recoverable. Section 43D of the Income-tax Act was later amended to include cooperative banks, but for the relevant year the controlling test was whether real income had accrued. The issue was answered in favour of the assessee and against the Revenue.

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Issues: Whether overdue interest on non-performing assets in the hands of a cooperative bank was taxable on accrual basis.

Analysis: The assessee bank followed the mercantile system, but the interest in question related to assets treated as non-performing under RBI prudential norms. The decision relied on the line of authority holding that, for income recognition, RBI directions under the Reserve Bank of India Act have overriding effect and that interest on NPAs does not accrue as real income when recovery is uncertain. The Court noted that Section 43D of the Income-tax Act, 1961 had subsequently been amended to include cooperative banks, but the issue for the year in question was governed by the principle that such interest could not be taxed merely on notional accrual. The Court also distinguished the revenue's reliance on Southern Technologies Ltd. and accepted the view that income recognition and tax computation are distinct, yet no accrual arises where the interest itself has not become real income.

Conclusion: The issue was answered in favour of the assessee and against the Revenue.

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