Income: Interest: Accrual of: Mercantile system: Section 5 of Income-tax Act, 1961: NBFC; Interest on loans given: Loans became non-performing assets: Interest not received and possibility of recovery nil: Interest not accrued.

The assessee, a non-banking financial company, had given interest-bearing loans to group concerns. In the relevant year, the loans had become non-performing assets in terms of the guidelines issued by the Reserve Bank of India. In the relevant year, the assessee did not show the interest in the P&L A/c on the ground that it was unlikely to receive the interest thereupon and thus the interest had not accrued to the assessee in the relevant assessment year. The Assessing Officer held that since the assessee is following mercantile system of accounting the interest had accrued to the assessee and was to be treated as income of the assessee u/s.5. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under :

“(i) The Tribunal had accepted the contention of the assessee that since the recovery of the principle amount of loan itself was doubtful, a decision was taken as a prudent businessman and interest was not accounted for in the books of account. According to the assessee, under these circumstances, there was no real accrual of interest and interest was not taxable in the hands of the assessee having regard to the principles of real income by holding that there was no accrual of real income and, therefore, it did not become income in the hands of the assessee u/s.5 of the Act.

(ii) The Tribunal had also held that merely because the assessee and the borrowers were known to each other, that would not be sufficient to render the financial position of borrower company better, so as to increase the likelihood of interest payment to the assessee.

(iii) On non-performing assets where the interest was not received and possibility of recovery was almost nil, it could not be treated to have been accrued in favour of the assessee.”