2026 (2) TMI 270 - HC - Income Tax

Interest income on NPA classification and taxability rejected where fresh advances show recoverability; writ relief denied.

Interest income on NPA was held taxable where the taxpayer continued to make substantial fresh advances to the same borrowers, so commercial reality ... Interest income on NPA - underlying loan had qualified as an NPA due to interest remaining outstanding for more than six months - statutory remedy of appeal u/s 260A - NPA classification - accrual of income - petitioner sought to write-off interest amounts that had been accrued in earlier assessment years and had been duly offered to tax on the grounds that these amounts had remained outstanding and unpaid for a period exceeding six months, thereby rendering them uncollectible and justifying their treatment as written-off amounts in accordance with the established norms for recognition of income from NPAs. ITAT distinguishing the loans advanced to two parties as fresh advances were made to these borrowers - petitioner contended that this distinction has no basis in the RBI circular or Accounting Standard-9 issued by the ICAI both of which do not recognize subsequent advances as a disqualifying factor for NPA classification. Maintainability of Writ Petition under Article 226 of the Constitution - Bench is of considered opinion that the petitioner has admitted that an alternative remedy of appeal u/s 260A of the Act was available, which provided for an appeal to the High Court against the order of the Income Tax Appellate Tribunal on any substantial question of law within a period of 120 days from the date of receipt of the order. Petitioner failed to avail this statutory remedy within the prescribed time limit and has now sought to invoke writ jurisdiction as a substitute for the appellate remedy that has been allowed to lapse. The explanation offered by the petitioner that important legal documents were misplaced during office relocation and could not be traced for nearly a year until the preparation of returns for assessment year 2009-2010, is wholly unsatisfactory and reflects serious administrative lapses and also lack of due diligence on the part of a petitioner engaged in financial services. To permit such an approach would undermine the carefully structured appellate framework under the Income Tax Act and encourage litigants to ignore statutory timelines. In the absence of exceptional circumstances such as lack of jurisdiction, violation of principles of natural justice or manifest arbitrariness, this Court is not inclined to entertain the present Writ Petition merely because the petitioner has allowed the statutory limitation period to expire due to its own negligence. Thus, as relying on Glaxo Smith Kline Consumer Health Care Private Limited [2020 (5) TMI 149 - SUPREME COURT] the first question of law stands decided in favour of the Revenue and against the petitioner. Interest income on NPA - NPA classification - ITAT has not committed any error of law in distinguishing between different categories of loans based on the actual conduct of the petitioner. The petitioner's primary contention is that all loans where interest remained overdue for six months or more must be classified as Non-Performing Assets under the RBI's Prudential Norms and that the RBI guidelines do not recognize subsequent advances as a disqualifying factor. However, this Court is of the view that while the RBI guidelines prescribe objective criteria for NPA classification, the determination of taxable income under the Income Tax Act must necessarily take into account the commercial reality and the actual conduct of the parties. ITAT has rightly observed that no prudent businessman would advance fresh loans to a borrower if there were genuine concerns about the recovery of principal or interest from earlier advances. The material on record clearly establishes that the petitioner made substantial fresh advances during the financial year 2002-2003. The petitioner's conduct in extending significant additional credit to these very same borrowers during the same financial year in which it claimed that earlier loans had become non-performing clearly demonstrates that the petitioner itself had confidence in the creditworthiness and financial soundness of these borrowers. The ITAT's approach of examining the totality of facts and the substance of the transaction, rather than merely applying the RBI guidelines in a mechanical manner is legally sound and ensures that the determination of taxable income is based on economic reality rather than accounting formalism. Accordingly, the second and third questions of law also stands decided in favour of the Revenue and against the petitioner. Principle of taxing real income - Petitioner has strongly relied upon the principle that income tax can only be levied on real income and not on notional income and has contended that interest income accruing on Non-Performing Assets is merely a book entry that does not represent real income unless actually realized. While this Bench acknowledges that the principle of taxing real income is indeed a fundamental tenet of income tax law, the application of this principle must be contextual and fact-specific. In the present case, the conduct of the petitioner in making fresh advances to the very same borrowers whom it claims were unable to service their existing debt completely undermines the assertion that the interest income was merely notional and wholly unrealizable. If the petitioner genuinely believed that these borrowers were in financial distress and unable to pay interest on existing loans, thereby rendering the accrued interest notional and uncollectible then the petitioner would not have exposed itself to further credit risk by extending substantial additional loans to the same borrowers. The fact that the petitioner chose to make fresh advances and in the case of M/s. Prathima Estates Limited, even received interest payment within five days clearly establishes that the petitioner expected to recover not only the fresh advances but also the earlier dues including the accrued interest. Issues: (i) Whether the writ petition under Article 226 is maintainable when an alternative statutory remedy by way of appeal under Section 260A of the Income-tax Act, 1961 was available and whether the delay in approaching the High Court is adequately explained; (ii) Whether the ITAT erred in declining to treat loans to M/s. Prathima Estates Ltd., M/s. Elgen (India) Ltd. and M/s. Netxcell Ltd. as Non-Performing Assets on the ground that fresh advances were made during the relevant year; (iii) Whether the petitioner's conduct of making fresh advances to the same borrowers during 2002-03 is relevant to NPA classification under RBI Prudential Norms and AS-9; (iv) Whether the principle that income tax is leviable only on real income (notional income exception) applies when the assessee voluntarily extends fresh credit to the borrower.Issue (i): Whether the writ petition is maintainable given availability of appeal under Section 260A and adequacy of explanation for delay.Analysis: An effective statutory appeal remedy under Section 260A existed with a 120-day limitation. The petitioner failed to file within the statutory period and offered an explanation of misplacement of records due to office relocation. The explanation was evaluated against established principles limiting exercise of writ jurisdiction where alternative efficacious remedies exist and where delay arises from lack of due diligence. Relevant authorities emphasize restraint in exercise of Article 226 when statutory remedies are available and the delay is not shown to result from exceptional circumstances that would justify bypassing the statutory appellate mechanism.Conclusion: Issue (i) decided against the petitioner and in favour of the Revenue; the writ petition is not maintainable on the ground of unexplained/negligent delay in availing the statutory remedy.Issue (ii): Whether ITAT erred in not treating specified loans as NPAs because fresh advances were made.Analysis: RBI prudential norms and AS-9 set objective criteria for NPA classification, but determinations of taxable income require consideration of commercial reality. The pattern and magnitude of fresh advances and payments during the same financial year were examined to assess whether earlier advances were truly doubtful of recovery. The continuance of substantial fresh credit and receipt of interest in the case of one borrower were relevant indicia undermining the claim that earlier loans were non-performing.Conclusion: Issue (ii) decided against the petitioner and in favour of the Revenue; ITAT's distinction based on subsequent advances and commercial conduct is upheld.Issue (iii): Whether the petitioner's conduct in making fresh advances is relevant and material to NPA classification for tax purposes.Analysis: The overall conduct, including repeated fresh advances and interest receipt, bears on the substance of transactions and the likelihood of realization. Regulatory prudential classification for banking/regulatory purposes does not automatically determine taxable income; factual commercial conduct may rebut a claim that interest was unrealizable.Conclusion: Issue (iii) decided against the petitioner and in favour of the Revenue; the petitioner's conduct is material and justifies the differential treatment of loans.Issue (iv): Whether the principle that tax is leviable only on real income (notional income exception) applies where assessee voluntarily continues commercial relations by extending fresh credit.Analysis: While taxing only real income is a recognized principle, its application is fact-sensitive. Voluntary extension of substantial fresh credit and receipt of interest indicate expectation of recovery and convert accrued interest into real income for tax purposes. Prudential non-recognition for regulatory capital purposes does not automatically convert the accrued interest into notional income for tax assessment where commercial reality indicates recoverability.Conclusion: Issue (iv) decided against the petitioner and in favour of the Revenue; the notional-income argument fails on the facts due to petitioner's conduct.Final Conclusion: The writ petition is dismissed on grounds of maintainability and on merits; the impugned orders of the Income Tax Appellate Tribunal dated 16.11.2007 and 06.06.2008 are upheld and confirmed.Ratio Decidendi: Where an efficacious statutory appeal remedy exists and delay is not shown to be due to exceptional circumstances, writ jurisdiction should not be invoked; further, for determination of taxable income, commercial reality and conduct (including subsequent advances) may be relied upon to assess whether accrued interest on loans represents real and taxable income despite regulatory prudential non-recognition for banking/regulatory purposes.