RBI income-recognition norms, held-to-maturity security amortisation, and section 14A disallowance capped at exempt income

Income recognition on non-performing assets was governed by RBI prudential norms, which prevailed by virtue of section 45Q of the Reserve Bank of India Act, so accrual taxation of such interest was not required. Amortisation of premium on government securities held to maturity was permissible where RBI norms and CBDT guidance required or recognised spread-over-to-maturity treatment. Disallowance under section 14A read with rule 8D could not exceed exempt dividend income, so where the assessee had already disallowed an amount equal to that income, no further addition was warranted.

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Issues: (i) Whether interest accrued on non-performing assets could be taxed despite the RBI income-recognition norms and the statutory override under the Reserve Bank of India Act, 1934; (ii) whether amortisation of premium paid on acquisition of government securities held to maturity was allowable; (iii) whether the disallowance under section 14A read with rule 8D could exceed the amount of exempt dividend income earned.

Issue (i): Whether interest accrued on non-performing assets could be taxed despite the RBI income-recognition norms and the statutory override under the Reserve Bank of India Act, 1934.

Analysis: The disputed interest related to assets classified as non-performing, and the record did not clearly show that the overdue period required for treatment under section 43D and rule 6EA was satisfied. The RBI directions on income recognition were held to prevail by reason of section 45Q of the Reserve Bank of India Act, 1934. On that footing, income from non-performing assets was not required to be recognised on accrual basis merely because the assessee followed the mercantile system.

Conclusion: The addition on account of interest on non-performing assets was not sustainable and was correctly deleted.

Issue (ii): Whether amortisation of premium paid on acquisition of government securities held to maturity was allowable.

Analysis: The bank was required by RBI norms to maintain and hold such securities in the prescribed portfolio and to amortise premium over the remaining period to maturity. The CBDT instruction dealing with assessment of banks also recognised amortisation of premium on held-to-maturity securities, and the binding administrative guidance supported the claim. The facts showed no dispute about the nature of the securities or the method of amortisation adopted.

Conclusion: The amortisation claim was allowable and the disallowance was rightly deleted.

Issue (iii): Whether the disallowance under section 14A read with rule 8D could exceed the amount of exempt dividend income earned.

Analysis: The assessee had earned exempt dividend income and had itself made a disallowance to that extent. The ceiling principle applied, under which disallowance under section 14A cannot exceed the exempt income of the year. Once the assessee had already disallowed an amount equal to the exempt income, no further addition could be made under rule 8D.

Conclusion: The further disallowance under section 14A read with rule 8D was not justified.

Final Conclusion: The Revenue's substantive challenges failed, and the assessed additions on the three decided issues were not restored.

Ratio Decidendi: For banks, income recognition on non-performing assets is governed by the RBI's mandatory prudential norms having overriding force under section 45Q of the Reserve Bank of India Act, 1934; amortisation of premium on held-to-maturity securities is allowable where supported by RBI/CBDT norms; and disallowance under section 14A cannot exceed the exempt income earned in the relevant year.

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