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Issues involved: Assessment of interest on Non-Performing Assets (NPA) u/s mercantile system of accounting.
Summary: For the Assessment Year 2001-02, the respondent assessee declared a loss of &8377; 28,55,795. The Assessing Officer (AO) observed that interest on NPA amounting to &8377; 19.57 lakhs was not recognized by the assessee. The AO contended that under the mercantile system of accounting, accrued interest on loans is taxable whether received or not. The assessee, being an NBFC, argued that interest on NPA cannot be treated as income until actually received, citing RBI guidelines under Section 45JA of RBI Act, 1934. The CIT(A) ruled in favor of the assessee, and the ITAT upheld the decision. The Revenue challenged this before the High Court under Section 260A of the Income Tax Act. The High Court referred to a recent Supreme Court judgment emphasizing that RBI Directions do not impact the taxability of income under the IT Act. It highlighted the need for the AO to determine if interest income should be recognized based on real income theory, considering the uncertainty in collection. The AO should have assessed if the loan had become an NPA with no likelihood of interest accruing. The High Court set aside previous orders and remitted the case to the AO for re-examination in light of the Supreme Court's guidance. Therefore, the High Court directed a fresh assessment by the AO to determine the taxability of interest on NPA, considering the real income theory and RBI guidelines, as per the Supreme Court's decision in a similar case.
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