Explainer: Draft Income-Tax Rules 2026 to expand HRA relief, tighten scrutiny on rent claims, FTC, audit disclosures

The Centre’s Draft Income-tax Rules, 2026 signal a sweeping overhaul of compliance standards for salaried individuals, cross-border taxpayers and companies. If cleared by Parliament alongside the Income Tax Act, 2025, the new framework will take effect from April 1, 2026, ushering in stricter documentation norms and expanded disclosure requirements.

While the proposal widens House Rent Allowance (HRA) benefits for select cities, it simultaneously increases scrutiny over rent claims, foreign tax credits and corporate audit observations.

HRA 

Currently, salaried employees residing in Mumbai, Delhi, Kolkata and Chennai can claim HRA exemption of up to 50% of salary under the old tax regime. For other cities, the limit is capped at 40%.

The draft rules propose adding Bengaluru, Hyderabad, Pune and Ahmedabad to the 50% category, recognising their rising rental costs and status as major employment hubs. Employees elsewhere will continue under the 40% ceiling.

As per Rule 279 of the draft, the exempt portion of HRA will remain the lowest of:

Actual HRA received

Rent paid minus 10% of salary

50% of salary (for the eight specified cities) or 40% (others)

For this purpose, salary includes basic pay and dearness allowance, where applicable, but excludes other allowances and perquisites. HRA exemption continues to be available only under the old tax regime.

End of “Paper-Only” claims

A key compliance shift comes through proposed Form 124, which requires employees claiming HRA to declare their relationship with the landlord.

This targets fictitious or inflated rental arrangements, especially cases where rent is shown as paid to close family members without adequate documentation.

Sandeepp Jhunjhunwala, Partner at Nangia Global Advisors, said:
"From a governance perspective, genuine arrangements would remain protected, while artificial claims... could be identified with greater precision."

While genuine rent paid to parents or relatives remains permissible, taxpayers must now ensure ownership proof exists, rent is paid through traceable channels, and proper receipts and PAN details are maintained. The compliance burden at the employer-reporting stage will increase significantly.

Foreign Tax Credit

Cross-border taxpayers may face even greater scrutiny. Proposed Form 44, relating to income from foreign jurisdictions and Foreign Tax Credit (FTC), places enhanced responsibility on accountants.

They will be required to independently examine foreign withholding certificates, payment proofs, exchange rate conversions, and treaty eligibility conditions such as beneficial ownership and tax residency status.

Jhunjhunwala cautioned about operational complexities, stating:
"Accountants would be required to interpret treaty provisions such as limitation of benefits clauses, credit caps, source rules, etc., which require detailed documentation."

He further noted that compliance could become challenging in situations where foreign jurisdictions issue consolidated tax statements without income-wise breakups, taxes are paid in a different financial year than income is reported in India, or foreign tax assessments are provisional.

This means globally mobile professionals, NRIs and returning residents must prepare for higher documentation thresholds and potentially longer processing timelines.

PAN declarations

The draft rules also require companies applying for a PAN to declare that no existing PAN has already been issued to them, including through branch offices or prior withholding arrangements.

Jhunjhunwala highlighted the implications: "The legal consequences clause acts as a deterrent against multiple PAN holding and identity manipulation, strengthening database integrity, but also increases responsibility on applicants to ensure accuracy and proper record verification before submission."

Additionally, the revised Tax Audit Form 26 mandates explicit disclosure of whether audit qualifications—such as improper revenue recognition, doubtful receivables, incorrect inventory valuation or inadequate provisioning—have an impact on taxable income or book profits.

Companies must now evaluate and document the tax consequences of statutory audit remarks before finalising returns. The audit report must also disclose details of accounting software used, cloud storage location, IP address and the physical backup server in India.

(With PTI inputs)