The Reserve Bank of India (RBI) reversed its deduction of the Rs 1,274.2 crore from the account of Telangana for tax dues after a finance ministry order overruled the claims of the income tax (IT) department.

With this reversal, the dispute between the Telangana government and the I-T department is set to resume as the reversal will now leave the taxman's claim unsettled.

The RBI, which is a banker to states, had to deduct the amount from the state government's account after the I-T department threatened to treat the RBI as a tax defaulter if it failed to deduct since it obtained an order from the high courts of Andhra Pradesh and Telangana in its favour.

Tax claims arose after the Andhra Pradesh Beverages Corporation, a liquor distributor in the erstwhile Andhra Pradesh state, had tax dues of the said amount to the Income Tax department.

After the state was split, the newly-created states -Telangana and Andhra Pradesh-were tossing the claims at each other. Subsequently , the Income Tax department secured a court order saying that the Telengana government is liable to pay the tax.

But the finance ministry had said the RBI could do so only by following constitutional procedures.

"The consolidated fund of a State can be debited only after the due process of appropriation," the ministry said on August 31."Any decision to debit the cash balance of any state by RBI should be based on some executive order issued by the Competent Authority after following the legislative process of appropriation."