The Indian government is currently reviewing a proposal to amend the Income Tax Act to align the definition of Non-Performing Assets (NPAs) with that of the Reserve Bank of India (RBI)-a move that could significantly ease tax burdens for banks and financial institutions.
As it stands, there is a key mismatch in NPA classification:
- The RBI classifies loans as NPAs if interest or principal remains overdue for more than 90 days.
- While under the Income Tax Act, this period extends to more than six months.
This disconnect has led to cases where banks are taxed on notional interest income that has not yet been recognized in their books-resulting in unjust tax liabilities, especially in situations where loans are overdue between 90 and 180 days.
Discussions Underway Across Ministries and Industry
According to officials familiar with the matter, banks made formal representations in May to the Department of Financial Services (DFS), which has since escalated the issue to the Revenue Department within the Ministry of Finance. The Indian Banks' Association (IBA) has also submitted a separate appeal.
In response, a committee comprising tax officials, industry representatives, and members from the Institute of Chartered Accountants of India (ICAI) is now reviewing the matter as part of the broader draft Income Tax Law reforms.
Focus on Section 43D and Provisioning Norms
Currently, Section 43D of the Income Tax Act governs the taxation of interest income from NPAs. It stipulates that such income is to be taxed on a realization basis or when credited to the profit and loss account, whichever is earlier. However, tax authorities sometimes insist on taxing accrued interest beyond 90 days-even when not recognized due to RBI norms.
Banks are also pressing for increased deductions on provisioning for NPAs under Section 36(1)(viia). Presently, lenders can claim a deduction of up to 8.5% of gross total income for such provisions. The industry now seeks to raise this cap to 15%, citing rising defaults and the need for greater fiscal space to strengthen balance sheets. This provision also applies to NBFCs and housing finance companies.
Potential Impact and Industry Sentiment
If the government approves the proposed amendments, banks' bottom lines could see an immediate improvement. As per Q4 FY25 data, the gross NPAs (GNPAs) of Scheduled Commercial Banks (SCBs) stood at a significant Rs 4.16 lakh crore.
"The NPA recognition principles are not clearly aligned, leading to instances where the tax department seeks to tax notional income," noted a senior tax advisor. "Aligning tax laws with RBI's 90-day norm will promote consistency, reduce litigation, and ensure fair tax treatment."
Industry experts believe this measure could reduce tax-related disputes, improve clarity in NPA taxation and lead to better provisioning in line with prudential norms. Past instances of litigation over this mismatch have cost both the government and financial institutions time and resources.
What's Next?
The government is expected to take a final view once the committee submits its recommendations. If accepted, the amendments could be included in upcoming Finance Bill updates, offering long-awaited relief to lenders and bringing India's tax framework in sync with global best practices.
CAclubindia
