Interest on NPAs and provision for standard assets were both held non-disallowable for a co-operative bank.

Interest on non-performing assets was not taxable on accrual basis where recovery remained uncertain and the co-operative bank, following binding RBI directions, consistently recognised such interest only on receipt; the addition was therefore unsustainable. A provision for standard assets was also held allowable for eligible banks, because the statutory deduction for provisions for bad and doubtful debts was not confined only to provisions linked to bad assets; the disallowance was deleted and the claim sustained.

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Issues: (i) Whether interest income relatable to non-performing assets was taxable on accrual basis despite the assessee following the mercantile system of accounting. (ii) Whether the provision made for standard assets was disallowable as a contingent liability or was allowable under section 36(1)(viia) of the Income-tax Act, 1961.

Issue (i): Whether interest income relatable to non-performing assets was taxable on accrual basis despite the assessee following the mercantile system of accounting.

Analysis: The assessee was a co-operative bank governed by RBI directions and had consistently recognized interest on NPAs only on actual receipt basis. The decisive factor was the uncertainty of recovery, which prevented real accrual of income. The accounting treatment was supported by the RBI framework and the principle that income cannot be taxed unless it has really accrued. The issue was treated as covered by the earlier coordinate bench view and by the statutory scheme recognising the primacy of RBI directions in such matters.

Conclusion: The addition on account of interest on NPAs was not sustainable and the relief granted by the first appellate authority was upheld.

Issue (ii): Whether the provision made for standard assets was disallowable as a contingent liability or was allowable under section 36(1)(viia) of the Income-tax Act, 1961.

Analysis: The provision was examined in the light of the statutory deduction for provisions for bad and doubtful debts available to eligible banks. The provision under consideration was held not to be excluded merely because it related to standard assets. The reasoning accepted that the deduction under section 36(1)(viia) is linked to the statutory computation for banking entities and is not confined only to provisions tagged as bad assets. The appellate authority's view was supported by the coordinate bench decision relied upon in the order.

Conclusion: The disallowance of the provision for standard assets was rightly deleted and the assessee's claim was sustained.

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

Ratio Decidendi: Interest on NPAs does not accrue for taxation purposes where recovery is uncertain and the asset is classified as non-performing in accordance with binding RBI directions, and a provision for standard assets may fall within the statutory deduction available to eligible banks under section 36(1)(viia).

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