Bird's Eye View on sum payable to micro and medium enterprises disallowed u/s 43B(h) of the IT Act, 1961

Introduction

The Income-tax Act, 1961 (for brevity 'Act') permits the deduction of expenses based on the accounting method adopted by the taxpayer. If the taxpayer uses the cash system of accounting, the deduction has been granted based on actual payments made. However, if the taxpayer follows the mercantile system of accounting, the deduction has been allowed based on accruals.

Section 43B of the Act provides a list of expenses to be allowed as deduction under the head 'Income from business and profession'. It states some expenses that can be claimed as deduction from the business income only in the year of actual payment and not in the year when the liability to pay such expenses is incurred even if the assessee follows mercantile basis of accounting. It is pertinent to note that the aforesaid section covers only the sum payable in respect of which deduction is otherwise allowable under this Act.

The Finance Act, 2023 in order to promote the timely payments to micro and small enterprises vide socio-economic welfare measures inserted clause (h) in section 43B of the Act to include sum payable by the taxpayer to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (for brevity 'MSMED Act').

It means that if payment is made to the micro and small enterprises beyond the time limit specified under the MSMED Act, the said payment is allowed in the previous year in which it is actually paid.

The relevant extract of memorandum explaining the purpose of introducing this stringent provision is reiterated as under:

"In order to promote timely payments to micro and small enterprises, it is proposed to include payments made to such enterprises within the ambit of section 43B of the Act. Accordingly, it is proposed to insert a new clause (h) in section 43B of the Act to provide that any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 shall be allowed as deduction only on actual payment. However, it is also proposed that the proviso to section 43B of the Act shall not apply to such payments."

The core essence of the recently added provision is summarized as follows:

• Applicability: It is noteworthy that this newly introduced provision will apply to the payments made in previous year 2023-24 (assessment year 2024-25) and subsequent assessment years.
• Scope: Only micro and small enterprises as defined under section 2 of MSMED Act are considered as suppliers who have filed a memorandum with the specified authority (i.e., Udyam Registration Portal) for the purpose of section 43B(h) of the Act. The classification of micro, small, and medium enterprises is determined by the composite criteria of net investment in plant and machinery and net turnover, as stated in section 2 of the MSMED Act.  Further, it is important to note that this will not apply to the enterprises categorized as medium enterprises under MSMED Act.
• Components of disallowance: If the payment to the Micro or Small Enterprise includes GST, the disallowance is limited to the amount excluding GST if the GST is claimed as Input Tax Credit (ITC) in the accounting records. Nevertheless, if the purchaser chooses not to claim the input tax credit under GST and considers it as an expense in its Profit and Loss account, deduction against GST will solely be permitted based on the actual payment made.

In respect of expenses incurred towards interest on delayed payment, this will not be allowed to be deducted while calculating returned income as emphasized by section 23 of the MSMED Act.

Further, if any advance payment is made to micro and small enterprise, this will be allowed to be deducted in year of payment itself irrespective of the fact that this is not due to be paid in the said previous year.

Allowances for payment made after financial year but before due date of filling return of income

The proviso of section 43B of the Act provides that if payment is made for specified expenditure after the end of previous year but before due date of filling return of income under section 139(1) of the Act, this shall be allowed while computing returned income for the relevant previous year in which it was incurred. The distinguishing factor of newly inserted clause (h) is that this proviso is not applicable to payments made to micro and small enterprises beyond the time limit specified under section 15 of the MSMED Act.  

The example provided below will serve as a clear explanation for this matter:

For example: If ABC Ltd. is required to make payment for the goods purchased to PQR Ltd. which is qualified as micro enterprise and the due date of payment is 20th January 2024 as specified in section 15 of the MSMED Act discussed in later part of the article) and the payment of the same is made on:

• 17th January 2024: No disallowance is attracted as payment made with due date.
• 28th February 2024: No disallowance is attracted as payment of the same is made within the relevant previous year
• 20th April 2024: Disallowance is required to be made while calculating returned income even if it gets paid before due date of filling return of income.

Time limit for payment prescribed under MSMED Act

Section 15 of the MSMED Act laid down the criteria of due date of payment to micro and small enterprises. It states that the buyer is obligated to make payment for any goods or services provided by any supplier on or before the mutually agreed upon date, as stated in writing. It is important to note that this agreed date must not exceed a maximum of 45 days.

If there is no agreement in this behalf, the buyer shall require to make payment before the "appointed date".

As per section 2(b) of the MSMED Act, "appointed day" means the day immediately after the expiry of the period of 15 days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier.

"The day of acceptance" means the day of the actual delivery of goods or the rendering of services.

Where any objection is made in writing by the buyer regarding the acceptance of goods or services within 15 days from the day of the delivery of goods or the rendering of services, "the day of acceptance" means the day on which the supplier removes such objection.

Where no objection is made in writing by the buyer regarding the acceptance of goods or services within 15 days from the day of the delivery of goods or the rendering of services, the day of the actual delivery of goods or the rendering of services is "day of deemed acceptance".

The example provided below will serve as a clear explanation for this matter

It is noteworthy that the term "Agreement" is not defined under the MSMED Act. In common parlance, an agreement means when a person makes an offer and another person agrees to it irrespective of any oral or written communication. The same encompasses aspects such as specified deadlines, acceptance of goods or services, penalties for delayed payment, and methods for resolving disputes. Hence, if an invoice or purchase order contains these particulars, it can be considered as an agreement.

Applicability of section 43B(h) for payments made in respect of capital expenditure

Section 43B of the Act clearly states that it applies to sums payable in respect of which a deduction is otherwise allowable under the Act. It does not distinguish between the payments made on account of revenue and capital expenditure as section 37(1) of the Act does.

Therefore, section 43B(h) of the Act would apply on the payments made in respect of capital expenditure whose 100% deduction is admissible under section 30 to 36 of the Act. An example in this regard is 100% deduction of capital expenditure in respect of specified business is available while calculating returned income for specified previous year.

If a 100% deduction of capital expenditure is not allowable, there would be no disallowance with respect to depreciation on capital goods purchased if the MSE supplier of capital goods is not paid in time. This is because depreciation is not a "sum payable in respect of which deduction is otherwise allowable". It is important to note that depreciation under section 32 of the Act does not fall under the ambit of section 43B of the Act.

Applicability of section 43B(h) for provisions debited to profit and loss Account

Provisions which are debited to Profit and loss Account during the year under consideration represent the sum payable to various parties which are otherwise allowable under section 37(1) of the Act. Therefore, these fall under the preview of section 43B(h) of the Act and required to be disallowed if not paid within the previous year in which it was incurred.

Applicability of section 43B when the taxpayer opts for presumptive taxation scheme

Section 43B(h) begins with a non-obstante clause "notwithstanding anything contained in any other provision of this Act". Therefore, apparently, section 43B overrides all provisions of the Act including provisions of presumptive taxation under section 44AD, section 44ADA, section 44AE and section 44BBB.

However, sections 44AD, 44ADA, 44AE, 44BBB also begin with non-obstante clauses as "Notwithstanding anything to the contrary contained in Sections 28 to 43C,…….'" Therefore, section 43B(h) overrides all other provisions of the Act except sections 44AD, 44AE, 44ADA, 44BBB.

Therefore, section 43B(h) will not apply to eligible assessee-buyers who opt for presumptive taxation under sections 44AD, 44AE, 44ADA and 44BBB.

Applicability of section 43B when the taxpayer is charitable trust

Section 11 of the Act provides that the returned income shall not include the income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied towards charitable or religious purposes in India.

It is firmly established legal principle that the term 'income' mentioned in section 11(1) must be calculated in accordance with commercial principles and not in accordance with the regular provisions of the Act. Stated differently, organizations registered under section 12AB are not subject to the application of section 14 and the five heads of income.

It may be noted that under sections 11 to 13, there are specific references to the provisions of 'Profits & Gains of Business or Profession' which have been made applicable to the computation of income under section 11, such as the disallowances for cash payments above INR 10,000 or disallowances for non-deduction of tax on payments made to residents. However, there is no reference to disallowance under section 43B(h) while computing income under section 11.

Hence, the question of disallowance under section 43B(h) will not arise while computing the application of income under section 11 of the Act.

Conclusion

Since micro and small enterprises contribute significantly to the growth and development of Indian economy, this is the welcome step of the Government of India to better settle the dues in specified time frame. In addition to this, this newly introduced provision has distinguishing factor that payments made to micro and small enterprises before due date of filling return of income for relevant previous year has not allowed while calculating returned income.

It is pertinent to note that the taxpayers have to track the record of their suppliers on financial year wise as classification can be changed based on composite criteria of net investment in plant and machinery and turnover.