Banks Push for Tax Relief on NPA Interest: Government Weighs Proposal

The core problem: Taxation of unrealized income

Indian banks have pressed the government to modify the Income Tax Act so that interest income on non-performing assets (NPAs) is not taxed.

The existing tax regime levies charges on notional interest income on NPAs despite such income not being recorded in balance sheets because of Reserve Bank of India guidelines.

The discrepancy between RBI’s NPA classification (90 days overdue) and the Income Tax Act’s definition (six months overdue) has led to litigation and financial strain on banks.

Proposed Amendments and Industry Demands

Banks have requested that the tax law align with RBI’s NPA recognition principles to prevent unjust tax liabilities.

The Indian Banks' Association (IBA) has also requested an increase in the NPA provisions deduction to 15% of gross income from 8.5%.

The proposal is being reviewed by a committee consisting of tax officials, industry members, and the Institute of Chartered Accountants of India.

Possible Banking Sector Impact

The amendments, once approved, would immensely benefit the financial position of banks by bringing down tax on unrealized income.

As of Q4 FY25, scheduled commercial banks' gross NPAs were at ₹4.16 lakh crore, emphasizing the extent of the problem.

The action is likely to improve liquidity and profitability, enabling banks to dedicate more resources to lending and economic growth.

Government's Response and Next Steps

The Department of Financial Services alerted the problem to the revenue department in May, issuing calls for discussions over potential legislative amendments.

Finance ministry is evaluating the proposal's viability in terms of its impact on tax revenues and banking stability.

A decision is likely in a few months, with industry players keeping a close eye on developments.

Sources: Economic Times, RBI Notifications.