The introduction of the Income Tax Act, 2025 and the Income Tax Rules, 2026 were positioned as a modernising reform, replacing the legacy regime under the Income Tax Act, 1961 and Income Tax Rules, 1962. However, despite structural changes, certain foundational inconsistencies persist, particularly in the taxation of income from house property.

The core issue lies in the taxation of notional rental income, even where such income is not actually realised. Although statutory relief exists for unrealised rent in the Act now, it still remains as a restrictive condition that makes the exception useless.

As per Section 20 of the Act, the annual value of property consisting of any buildings or lands appurtenant thereto owned by the assessee shall be chargeable to income tax under the head income from house property. In furtherance of Section 21(1) of the Act, the “annual value” will be the higher of: (i) the sum for which it may be reasonably be expected to let from year to year or (ii) the actual rent received or receivable by the owner, if the property or any part of it is let. As per Section 21(4) of the IT Act, the rent which cannot be realised by the owner shall not be included in computing the actual rent received or receivable, subject to the rules made in this behalf. Therefore, it may be stated that Section 21(4) provides an enabling clause which allows relief to the relevant assessee from the applicability of “reasonable expectation of rent in the normal course”, albeit with the applicability of the relevant rules.

In this regard, Rule 21 imposes the condition that Section 21(4) will be applicable only in cases where the defaulting tenant has vacated or been compelled to vacate the premises and the assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfies the Assessing Officer that legal proceedings would be futile. Therefore, any deduction in the “income from house property” bracket of the assessee shall only take place upon institution legal proceedings for eviction and other steps to recover the rent.

As it stands, the current provision in the statute is harshly worded and unjustified to tenants who have been occupants of a property for long periods of time. If an assessee wants to have the ability to claim appropriate deduction on account of default of the tenant, he must institute legal proceedings. The statute is unable to take into account any extenuating circumstances of the tenant occupying the property of the assessee (economic hardships, unavailability of liquidity for some reason). The statute further makes it unable for the assessee to waive off any rental amount on humanitarian or compassionate grounds (the tenant being an old person, disabled or a family with no other modes of accommodation). It will also result in loss of commercial value for the assessee as well, since mandatorily evicting the tenant and replacing them with another tenant will take some time, resulting in the cessation of the operation of the house property as an asset.

Indian tax jurisprudence has long recognised the principle that only real income, not hypothetical accruals, should be taxed. Since the Supreme Court's judgment in CIT v. Shoorji Vallabhdas and Co, courts have time and again emphasised that income must be real - not illusory or notional beyond commercial reality - for it to be liable for taxation.

However, the present framework taxes expected rent, even when recovery is doubtful and conditions relief on procedural compliance rather than substantive reality.

This results in a doctrinal inconsistency: the law acknowledges unrealised income but refuses relief unless the taxpayer behaves in a prescribed manner. Such a framework effectively penalises commercial prudence and humanitarian considerations.

The eviction requirement produces several distortions:

• Forced evictions: Landlords may evict tenants solely to secure tax relief, even where continuation of tenancy is otherwise desirable.

• Vacancy loss: Replacement of tenants is not immediate, resulting in actual economic loss as the property may stay vacant for a longer duration.

• Litigation burden: Mandatory legal proceedings increase costs and judicial backlog.

• Moral hazard: As pointed out above, the law disincentivises compassionate conduct (like temporary rent waivers during financial distress).

In effect, the rule substitutes tax compliance for commercial judgment.

The Indian approach raises deeper concerns:

• Arbitrariness: Conditioning relief on eviction lacks a rational nexus with the objective of taxing income.

• Disproportionality: The burden imposed (litigation, eviction) is excessive relative to the benefit (tax relief).

• Overreach: The rules effectively override the statutory intent of granting relief.

This opens the door to a potential challenge under constitutional principles of equality and manifest arbitrariness.

Under the Income Tax (Trading and Other Income) Act, 2005, United Kingdom:

• As per Section 268, income from house property in the United Kingdom is taxed on the ‘profits’ as received from such income.

• In consonance with statute PIM2072, relief is available for bad debts, provided:

  • The debt is genuinely irrecoverable; and

  • Reasonable steps have been taken for recovery.

Crucially, the United Kingdom framework does not mandate eviction for declaring any non-payment of rent, which has been proven as a bad debt. Further, it does not mandate that legal proceedings have be taken and doesn't have to be proved that any legal proceedings would be futile to claim a bad debt, although reasonable steps must be taken for the recovery of the rent.

This reflects a more coherent alignment with the real income principle.

A more balanced framework would remove eviction as a mandatory condition and permit relief where the assessee demonstrates reasonable efforts to recover rent; or establishes that recovery would be futile or commercially unreasonable, at the time of his assessment.

A suggestion moving forward will be to delete Rule 21(b) and modify Rule 21(d) to read as:

 “The assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or at the time of assessment, satisfies the Assessing Officer that legal proceedings would be futile or unreasonable.”

This aligns relief with substantive reality rather than procedural formality.

The current framework governing unrealised rent reflects a deeper tension within Indian tax law between notional constructs and economic reality. By conditioning relief on eviction and litigation, it undermines both efficiency and fairness.

A shift toward a real income-based approach, supported by flexible evidentiary standards, would:

• Reduce unnecessary litigation;

• Preserve commercial relationships, and

• Ensure that Indian law is accommodative of all the possible situations that may arise when a tenant may fail to pay the rent.

In the absence of such reforms, the law risks continuing to tax income that does not, in any meaningful sense, exist.

Aanish Aggarwal is an advocate practising before the High Court of Gujarat.