The government is reviewing a proposal from banks to exempt the interest earned on non-performing assets by amending the income tax law to align the definition of NPAs with that of the banking sector regulator, the Reserve Bank of India.
The RBI classifies a loan as an NPA if the interest or principal remains overdue for more than 90 days, while the income-tax act classifies a loan NPA if this period is more than six months.
"In May, these suggestions were made to the Department of Financial Services, which in turn flagged the issue with the revenue department in the finance ministry," said an official requesting anonymity, adding that separately a representation has also been made by the Indian Banks' Association, or IBA.
A committee with tax officials, representatives from the industry and the Institute of Chartered Accountants of India has been tasked with the review of the draft income-tax law and is examining the issue, said another government official.
The section 43D under the income tax act specifically provides for taxation of interest income from non-performing loans. It is taxed either on a realisation basis or as a credit to the statement of profit and loss, whichever is earlier.
Lenders have also sought an increase in deduction for the provision made for NPA to up to 15% of the gross income from 8.5%. Under section 36(1)(viia) of the Income Tax Act, 1961, banks and financial institutions are allowed a deduction in respect of the provisions made for non- performing assets. The provision is also applicable to NBFCs and housing finance companies.
The industry had in the past flagged the issue citing numerous litigation at various courts.
If the government agrees to the proposed changes, banks' bottom lines will get a boost. As per current data, gross non-performing assets, or GNPAs, of scheduled commercial banks, or SCBs, stood at Rs 4.16 lakh crore as of Q4 FY25.
"The NPA recognition principles are not clearly aligned, leading to instances where the tax department seeks to tax notional interest income on NPAs, even though such interest is not recognized in books due to RBI norms," Sandeep Sehgal, Partner- Tax, AKM Global, a tax and consulting firm said.
This puts unjust tax liability on unrealised income as banks and financial institutions are required to pay tax on interest income beyond 90 days, Sehgal added.
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