RBI recognition of non-scheduled bank status and NPA income recognition rules governed deduction and accrual taxation

A co-operative bank notified by the RBI as a non-scheduled bank falls within the statutory scope of section 36(1)(viia), so the deduction was treated as allowable. Interest on non-performing assets was not taxable on accrual basis where, under RBI prudential norms, the bank did not recognise such income and the principal itself had become doubtful of recovery, so the addition was held unjustified. The Revenue's objections on both issues were rejected and the relief granted by the first appellate authority was sustained.

---

---

Issues: (i) Whether a co-operative bank notified by the Reserve Bank of India as a non-scheduled bank is entitled to deduction under section 36(1)(viia) of the Income-tax Act, 1961. (ii) Whether interest on non-performing assets can be brought to tax on accrual basis when the bank does not recognise such interest under RBI prudential norms.

Issue (i): Whether a co-operative bank notified by the Reserve Bank of India as a non-scheduled bank is entitled to deduction under section 36(1)(viia) of the Income-tax Act, 1961.

Analysis: The deduction under section 36(1)(viia) is available to a scheduled bank, a non-scheduled bank, and specified co-operative banks. The bank was shown to have been duly registered and notified by the Reserve Bank of India as a non-scheduled bank. The statutory definition of a non-scheduled bank under the Banking Regulation Act was treated as controlling for this purpose, and the Revenue's objection that the assessee was not eligible was found unsustainable.

Conclusion: The issue was decided in favour of the assessee, and the deduction under section 36(1)(viia) was held allowable.

Issue (ii): Whether interest on non-performing assets can be brought to tax on accrual basis when the bank does not recognise such interest under RBI prudential norms.

Analysis: The decision followed the principle that RBI prudential norms govern income recognition in respect of doubtful or non-performing assets, and that such norms have overriding force in the field of income recognition. Where the principal itself had become doubtful of recovery, interest thereon was treated as not having accrued. The reasoning of the Tribunal and the Delhi High Court on identical questions was applied, and the assessee's non-recognition of such interest was upheld.

Conclusion: The issue was decided in favour of the assessee, and the addition of interest on NPAs was held unjustified.

Final Conclusion: The Revenue's challenge failed on both substantive issues, and the relief granted by the first appellate authority was sustained.

Ratio Decidendi: Where a co-operative bank is recognised by the Reserve Bank of India as a non-scheduled bank, it falls within the statutory ambit for deduction under section 36(1)(viia); and interest on non-performing assets does not accrue for tax purposes when, under RBI prudential norms, the income has not truly arisen.

---