The main legal point established in the judgment is that the treatment of NPAs and non-recognition of interest income was justified under RBI's prudential banking norms and the concept of 'real income' as per the IT Act provisions.

S. RAVINDRA BHAT, J.

1. The following question of law was framed in this appeal, under Section 260A of the Income Tax Act, 1961:

“Did the Income Tax Appellate Tribunal (ITAT) fall into error in holding that the sum of Rs. 2,53,15,466/- brought to tax on account of notional interest was not justified.”

2. The assessee herein had advanced certain amounts to various concerns, i.e. M/s Jindal Equipment Leasing & Consultancy Services Ltd. and Mansarovar Investment Ltd. during the previous year relevant to assessment year 1997-98. Interest was accrued on the said loans upto assessment year 1998-99. Further, the Petitioner had advanced interest bearing loans to M/s Goswami Credits & Investment Ltd. during the previous year relevant to assessment year 1999-2000. Interest was accrued on the said loan till assessment year 2001-02. The assessee had not received interest for more than six months from its said debtors. As a Non-Banking Financial Company (NBFC) the assessee is bound by directions of the Reserve Bank of India. Such directions, require NBFCs to declare such advances as Non Performing Assets (NPA), when accrued interest on them is not paid by the debtor for six months, continuously. The assessee therefore treated the advances to its debtors as ICD, as NPA, and did not show interest income, which it said, was unrealizable. The Assessing Officer (AO), however, added interest as the assessee’s income holding that it had “accrued” to it even if it was actually unpaid as the assessee followed the mercantile system of accounting. The CIT (A) affirmed the AO’s order. The ITAT deleted such interest income.

3. The revenue argues that in respect of the three entities, the decision not to reflect revenue recognition, and treat the interest payable as NPA could not be allowed and the ITAT erred in holding that under RBI’s norms, the revenue recognition method adopted was in order. It was highlighted that there was cross shareholding of three entities which were given the credit facility which sets them apart from normal defaulting debtors. It was also submitted that the financial health of the three debtor companies was not essentially sound; furthermore, nearly 40% of the amounts advanced by the assessee were to the three companies. As such the revenue had a right to hold that the transactions were not at arms’s length and therefore, the explanation that the advances were NPAs could not be legitimately accepted.

4. Counsel for the assessee contested the arguments of the revenue. It was pointed out that the present appeal had been decided against the assessee earlier. Its appeal by special leave was tagged to the revenue’s appeals against the decision of this court in Commissioner of Income Tax v. Vishisht Chay Vyapar Ltd. 330 ITR 440. In that decision (Vishisht Chay Vyapar) the division bench had ruled that RBI’s prudential banking norms, embodied in its directions to banking and non banking entities, were as binding as accounting standards under Section 145 of the Income Tax Act, and reflection of income on notional basis, did not reflect the realistic assessment of real income. It was submitted that the Supreme Court, which also required this court to review its previous order, (allowing the revenue’s present appeal), approved the said judgment in Vishshit Chay Vyapar (supra). Learned counsel therefore, submitted that there is no infirmity in the tribunal’s reasoning, and that the revenue had accepted the treatment of such NPAs earlier, by the assessee.

5. In Vishshist Chay Vyapar (supra) this court had earlier ruled as follows:

“15. We have considered the respective submissions in proper their perspective. Before we embark on the discussion on these ITA 139/2008, ITA 466/2008, ITA 537/2008, ITA 408/2003 arguments, it would be useful to extract the relevant provisions of the RBI Act and NBFCs Prudential Norms (Reserve Bank) Directions 1998. Section 45Q of the RBI Act, which starts with non-obstante Clause, reads as under:-

"Chapter I