The Income Tax Act, 2025, alongside its subsequent Income Tax Rules, 2026, was introduced as part of an effort to update India’s tax framework, succeeding the older Income Tax Act of 1961 and Rules of 1962. Despite these reforms, challenges remain, especially concerning the taxation of income derived from house property. A central concern is the imposition of tax on notional rental income, even when such income is not realized. Although the current act offers statutory relief for unrealized rent, its restrictive conditions render the provision largely ineffective.
Current Statutory Framework
Under Section 20 of the Income Tax Act, the annual value of a property consisting of any buildings or adjoining lands owned by an individual is subject to income tax under the ‘income from house property’ category. Section 21(1) specifies that the ‘annual value’ is determined as the greater of either the expected rental value from year to year or the actual rent received or receivable if the property is let out.
Section 21(4) of the Act provides that rent which cannot be realized shall not be included when calculating the actual rent received or receivable, subject to relevant rules. Rule 21 requires that Section 21(4) is applicable only if the tenant has vacated or been compelled to vacate the premises, and the property owner has either taken all reasonable steps to initiate legal proceedings for rent recovery or has convinced the Assessing Officer that such proceedings would be futile. Therefore, deductions from ‘income from house property’ can only occur after legal proceedings for eviction and rent recovery are initiated.
This statutory requirement is often criticized for being overly harsh, particularly towards tenants with prolonged occupancy. Property owners must pursue legal action to claim deductions for tenant default, disregarding any tenant hardships or the owner’s humanitarian considerations. Furthermore, this requirement could result in financial losses for property owners due to the potential vacancy period when replacing tenants.
The Real Income Doctrine and Its Erosion
Indian tax jurisprudence has long emphasized that taxation should apply only to ‘real’ income, not hypothetical or notional amounts, as underscored by the Supreme Court in CIT v. Shoorji Vallabhdas and Co. However, the current rules tax expected rent, even when its recovery is uncertain, conditioning relief on procedural compliance rather than substantive reality. This creates a doctrinal inconsistency, penalizing commercial prudence and humanitarian considerations.
Practical and Economic Consequences
The requirement for eviction as a condition for tax relief distorts several aspects of property management:
- Forced Evictions: Landlords may evict tenants solely to secure tax relief, despite the desirability of continued tenancy.
- Vacancy Loss: The time taken to replace tenants can lead to actual economic losses due to property vacancy.
- Litigation Burden: Mandatory legal proceedings increase costs and contribute to judicial backlog.
- Moral Hazard: The law deters compassionate conduct, such as temporary rent waivers during tenant financial distress.
The Indian approach raises concerns about arbitrariness, disproportionate burden, and potential overreach, suggesting a possible challenge under constitutional equality principles.
Comparative Reforms in the United Kingdom
The United Kingdom’s Income Tax (Trading and Other Income) Act, 2005, under Section 268, taxes property income based on actual profits received. Relief for bad debts is available under statute PIM2072, provided the debt is irrecoverable and reasonable recovery steps have been taken. Notably, the UK does not require eviction to declare rent non-payment as a bad debt.
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A more balanced framework would remove eviction as a mandatory requirement, allowing for relief when an assessee demonstrates reasonable rent recovery efforts or establishes that recovery would be futile or commercially unreasonable at the time of assessment. Suggested reforms include the elimination of Rule 21(b) and amending Rule 21(d) to reflect this approach.
Conclusion
The existing framework for unrealized rent highlights a tension in Indian tax law between notional constructs and economic reality. Conditioning relief on eviction and legal proceedings undermines efficiency and fairness. A shift towards a real income-based approach, supported by flexible evidentiary standards, could reduce unnecessary litigation, preserve commercial relationships, and accommodate various tenant situations where rent remains unpaid. Without such reforms, the law risks taxing non-existent income.
Aanish Aggarwal is an advocate practicing before the High Court of Gujarat.
