Taxation of NPA interest: interest following RBI classification taxed on actual receipt; provisions for standard assets deductible.

Where a bank follows RBI classification and the mercantile system permitting postponement of revenue recognition when collection is uncertain, interest on assets classified as non performing is not taxed on accrual but is taxable on actual receipt; this approach was applied and accepted. Separately, provisions for standard assets made by specified banks fall within allowable provisions contemplated by section 36(1)(viia) and are deductible, with the tribunal precedent supporting allowability. Both contested additions by the Revenue were rejected and the appellate deletions were upheld.

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Issues: (i) Whether interest on non-performing assets (NPAs) of a co-operative bank following RBI guidelines and the mercantile system of accounting is taxable on accrual or on actual receipt; (ii) Whether provisions made for standard assets by a bank are allowable as deduction under section 36(1)(viia) of the Income-tax Act, 1961.

Issue (i): Whether interest on NPAs must be taxed on accrual despite the assessee following RBI directions to account for such interest on actual receipt.

Analysis: The accounting treatment followed pursuant to RBI guidelines and consistent application of the method of accounting under section 145 of the Income-tax Act, 1961 and applicable accounting standards permits postponement of revenue recognition where collection is uncertain. Where assets are classified as NPAs in accordance with RBI directions, interest thereon is not accrued for tax purposes and is to be recognised on actual receipt; coordinate tribunal precedent on identical facts was applied.

Conclusion: In favour of the assessee - interest on NPAs held taxable on actual receipt and not on accrual.

Issue (ii): Whether provision for standard assets constitutes an allowable deduction under section 36(1)(viia) of the Income-tax Act, 1961 or is a contingent liability not allowable as business expenditure.

Analysis: Section 36(1)(viia) allows deduction in respect of provisions for bad and doubtful debts made by specified categories of banks and computes allowable amounts with reference to total income and average advances rather than restricting the deduction to quantum of bad debts only; the provision for standard assets falls within the ambit of provisions contemplated by the main clause of section 36(1)(viia) and coordinate tribunal precedent supports allowability.

Conclusion: In favour of the assessee - provision for standard assets allowed as deduction under section 36(1)(viia).

Final Conclusion: Both contested additions challenged by the Revenue were rejected and the appellate authority's deletions upheld, resulting in dismissal of the Revenue's appeal.

Ratio Decidendi: Where a bank follows RBI classification and guidelines, interest on assets classified as NPAs is not treated as accrued income and is taxable on actual receipt; provisions for standard assets by specified banks fall within deductible provisions under section 36(1)(viia) of the Income-tax Act, 1961.

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