2019 (3) TMI 740 - HC - Income Tax

Interest on non-performing assets - Accrual of income - real income theory - taxable on accrual basis looking to the guidelines of the Reserve Bank of India - appellant is a non-banking institution engaged in providing financial assistance to its customers - HELD THAT - The appellant-assessee acting under the directives of the Reserve Bank of India with regard to prudential norms set out, taxing interest on NPA, therefore, cannot be justified on the real income theory. Followed decision in the case of Shri Mahila Sewa Sahakari Bank Ltd 2016 (8) TMI 377 - GUJARAT HIGH COURT The substantial question of law is answered in favour of the appellant-assessee.

Summary

Issues:
1. Taxability of interest on non-performing assets on accrual basis under the Income Tax Act, 1961.

Analysis:
The case involves the appellant, a non-banking institution providing financial assistance, filing a return of income for the assessment year 2009-10, declaring a total loss. The Assessing Authority disallowed deductions for provisions of doubtful debts, penal interest, and sundry debtors as they were sought on anticipation basis without actually arising during the year. The issue centered on whether interest on non-performing assets (NPA) is taxable on accrual basis as per RBI guidelines. The Tribunal affirmed the disallowance, citing that only accrued or known liabilities qualify for deduction under the Act. The Tribunal emphasized that income must be taxed once accrued, and both accrual and cash basis methods cannot operate simultaneously.

In various judgments, including Principal Commissioner of Income-tax-5 Vs. Shri Mahila Sewa Sahakari Bank Ltd., the courts held that taxing interest on NPA cannot be justified on the real income theory, especially when following RBI directives. The Supreme Court upheld decisions like Commissioner of Income Tax Vs. Vasisth Chay Vyapar Ltd., supporting that interest income on NPAs where recovery is unlikely cannot be treated as accrued. Recent decisions by High Courts, such as the Bombay High Court, further reinforced the stance that interest on NPA should not be taxed based on real income theory.

The High Court in the present case ruled in favor of the appellant, stating that taxing interest on NPA, when acting under RBI directives, is not justified on the real income theory. The judgments from various High Courts and the Supreme Court supported this view, emphasizing that interest on NPAs with low recovery possibilities should not be taxed as accrued income. Consequently, the order disallowing the deduction for uncharged interest on NPA was set aside, and the appellant's claim was allowed.