In the case of NBFCs, the provisions relating to income recognition and assets classification and provisioning bad and doubtful debt is governed by Non-Banking Financial (Non-deposit accepting or holding) Companies prudential norms (Reserve Bank) Direction, 2007 (Directions). Para 2 (i) (xiii) of the Directions defines Non Performing Asset (NPA) to mean:
- an asset in respect of which interest has remained over due for a period of six months or more.
- A demand or call loan, which has remained overdue for a period of six months or more from the date of demand or call or on which interest amount remained overdue for a period of six months or more.
Para 3 (2) of the directions provides that income including interest or any other charges on Non-Performing Assets shall be recognised only when it is actually realised. Any such income recognised before the asset became non-performing and remaining unrealized shall be reversed.
Therefore, Non-Banking Finance Companies are bound to comply with the Reserve Bank of India norms with regard to the income recognition and asset provisioning. As per these norms, if the interest income recognised by the company remains over due for a period of six months or more, the loan becomes a Non Performing Assets. After the loan becoming a Non Performing Asset, no interest can be recognised unless actually received. Unrealised interest which was earlier recognised should be reversed in the current financial year as per the accounting norms for NBFCs prescribed by the RBI.
Apropos the taxability of the interest which was recognised in the books but once the account become an NPA, was reversed in the same year in compliance with the RBI prudential norms, the Courts have recognised the theory of ‘real income’ and irrespective of the method of accounting followed, the tax payer could only be taxed on real income and not on any hypothetical income. Therefore, no tax could be levied on the notional unrealised interest that was so far recognised but reversed during the same year.
However, as held in Escorts Finance Ltd., New Delhi vs Department Of Income Tax (I.T.A .No.-36/Del/2012), the ‘real income’ theory can be applied to current year income and does not apply to reversal of income of the earlier year, which is already recognised. The real income theory does not come to the aid of the assessee in the case of reversal of earlier year income. Reversal of such income, which is already accounted as income in the earlier assessment year would be possible only by, part write off the debts. If the debts are written off in part i.e. to the extent of interest income sought to be reversed, then the judgment of the Hon’ble Supreme Court in the Case of T.R.F. Ltd. 323 ITR 397 (SC) would apply and the same would be allowed as bad debt u/s 36(1)(vii) of the Income Tax Act.