Apex Court ruled, Interest on NPA accounts taxable on receipt basis

Apex Court ruled, Interest on NPA accounts taxable on receipt basis

The Honorable SC in the case of Vasisth Chay Vyapar Ltd. ruled that income of NBFC's have to be computed in accordance with prudential norms of the RBI and that Section 45Q of RBI Act overrules Section 145 of Income Tax Act. Thus interest on NPA accounts will be taxable on receipt basis and not on accrual basis.

Facts of the Case:

  1. Taxpayer is a NBFC. Taxpayer advanced loan to a company, naming Shaw Wallace.
  2. Shaw Wallace Ltd. has become unable to repay the debt. There was so much financial crunch that Shaw Ltd could not even pay interest for 6 months.
  3. Due to default for a continuous period of 6 months, taxpayer showed loan advanced as NPA and did not show interest accrued as income after 6 months of default. Taxpayer did not show such accrued interest following the prudential norms issued by RBI.


Issues Involved:

  1. Whether taxpayer is right in not treating interest accrued after 6 months of default as income by following the mandatory principles laid down by RBI? or
  2. Whether taxpayer shall treat such interest as income irrespective of the fact that borrower has almost become bankrupt and has not discharged interest from more than 6 months. 
  3. Can provisions of RBI override the provisions of Income Tax Act in respect of accounting of interest income?


Provisions & Rulings:

  1. Section 145 of the Income Tax Act mandates that method of accounting shall be consistently followed by the assessee...So as per department, if the assessee is consistently following mercantile system, then interest on loans which have become NPA will also have to be treated as income as per mercantile system.
  2. Section 45Q of the RBI Act starts with non-obstante clause stating that, "Chapter IIIB to override other laws.—The provisions of this Chapter shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law."
  3. Madrs HC in the case of Elgi Finance Ltd. on similar grounds held that no interest could be said to have accrued on loans which were classified as NPAs.
  4. Apex Court in the case of Shoorji Vallabhdas observed that income tax is levied on real income and not some hypothetical income.


Hon'ble SC Held That:

  1. Mercantile system of accounting is relevant only for determination of point of taxation. Mercantile system has no relation with determination of income that is whether income is real or hypothetical.
  2. The assessee company being NBFC is governed by the provisions of RBI Act. In such a case, interest income cannot be said to have accrued to the assessee having regard to the provisions of section 45Q of the RBI and Prudential Norms issued by the RBI in exercise.


Essence of Above:

  1. The apex court ruling is a big relief for all NBFC's as well as banking companies....Once the borrower becomes NPA, there arises doubt regarding recovery of principle amount...In such scenario, levying tax on accrued interest on such NPA account totally becomes irrelevant. 
  2. Thus interest on NPA accounts will be taxable on receipt basis and not on accrual basis.
  3. Further due to rising NPA's bank faces lower capital adequacy ratio...In such a framework, demanding of tax on such interest whose chances of recovery are precious little, is draconian in nature.


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