Banks’ Proposal for Tax Relief on NPA Interest Under Review

The Indian government is reviewing a proposal from banks to amend the Income Tax Act and align the definition and treatment of Non-Performing Assets (NPAs) with the Reserve Bank of India’s (RBI) regulatory norms. This move aims to provide relief from taxation on unrealised interest income.

Key Regulatory Divergence

• RBI Definition of NPA:
  • Loan becomes NPA if interest or principal is overdue for more than 90 days.
• Income Tax Act Definition:
  • Loan is considered NPA only if overdue for more than 6 months.

Proposed Changes Under Consideration

1. Exemption of Interest on NPAs:
   • Amendment of Section 43D to prevent taxation of notional interest on NPAs unless realised or credited.
   • Would align tax treatment with RBI’s prudential norms.
2. Enhanced Provisioning Deduction:
   • Lenders have proposed raising tax-deductible provisioning for NPAs from 8.5% to 15% of gross income.
   • Relevant under Section 36(1)(viia) of the Income Tax Act.
   • Applicable to banks, NBFCs, and housing finance companies.

Government Review Process:

• Inter-ministerial Consultations:
  • Suggestions submitted to the Department of Financial Services (DFS) in May 2025.
  • DFS has flagged the issue to the Department of Revenue, Ministry of Finance.
• Stakeholder Committee:
  • Includes tax officials, industry representatives, and the Institute of Chartered Accountants of India (ICAI).
  • Reviewing changes to the draft Income Tax law, including NPA taxation norms.

Current Status of NPAs:

• Gross NPAs (GNPAs) of Scheduled Commercial Banks (SCBs) stood at ₹4.16 lakh crore as of Q4 FY25.

Implications if Accepted:

• Boost to Bank Profits:
  • Prevents tax outgo on unrealised income.
  • Encourages more realistic income reporting aligned with prudential norms.
• Reduced Litigation:
  • May lower tax-related disputes in courts over NPA-related interest income.

BS