Decoding the New Clause (H) of Section 43B of Income Tax Act

Background

As per the Income-tax Act the deduction of expenditure is allowed according to the system of accounting principles followed by the assessee. In case the assessee follows a cash system of accounting, the deduction should be allowed on an actual payment basis. In the case of a mercantile system of accounting, the deduction is allowed on an accrual basis.

However, Section 43B of the Income-tax Act, 1961 provides a list of several expenses which are allowed as a deduction on a payment basis. Thus, even if an assessee follows the mercantile method of accounting, deduction of the specified expenses shall be allowed if the payment is made on or before the due date of furnishing the return of income, except the sum payable to micro and small enterprises.

The Finance bill 2023 included a new clause (h) to section 43B of the income tax act 1961. To assure on-time payments, the stated clause inserted as a Socio-Economic Welfare Measure and has been realized through the Micro and small companies. This amendment aims to address the issue of working capital scarcity in this industry and promote prompt payments to micro and small businesses.

A new income tax provision requiring the assessee to pay off bills with MSME units within 45 days comes into effect from Assessment Year 2024-25.

The LAW

Section 43B pertains to "certain deductions to be only on actual payment"

The newly inserted clause h under Sec 43B states that "any sum payable by the assessee to a MICRO or SMALL enterprise beyond the time limit specified in 15 of the Micro, Small and Medium Enterprises Development Act, 2006,"

Analysis

The Central Government has issued Notification No. 2119(E), dated 26-6-2020, under Section 7(1) read with Section 7(9) of the MSMED Act. Para 3(1) of the said Notification provides that a composite criterion of investment and turnover shall apply for the classification of an enterprise as micro, small or medium. Para 1 provides that an enterprise shall be classified as a micro, small or medium enterprise on the basis of the following criteria:

15. "Where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day:

Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance."

['Appointed day' refers to the day immediately following the expiration of the fifteen-day period from the date of acceptance or the date of deemed acceptance of any goods or services by a buyer from a supplier.]

'Buyer' means a person buying any goods or receiving any services from a supplier for consideration.

Supplier means a micro or small enterprise which filed a memorandum under section 8(1) and includes : (a) National Small Industries Corporation, (b) Small Industries Development Corporation of a state/Union Territory, and (c) a registered company. Co-operative society, trust or body, selling goods or rendering services produced or provided by micro or small enterprises.

The Interpretation

The mentioned above clause shows that the payment will need to be made under the specified time duration in 15 of the Micro, Small, and Medium Enterprises Development Act, 2006 for qualifying the claim deduction of the sum liable to get paid to the micro and small enterprises.

This deduction is applicable in the previous year when the sum is actually paid. Clause (h) of Section 43B essentially states that any sum payable by a larger enterprise or entity to a registered MSME beyond the stipulated deadlines won't be considered a deductible expense in the year the liability was incurred.

Also in terms of Sec. 15 of the MSMED Act, payment terms cannot exceed 45 days. Hence, in a scenario where the payment terms have been set beyond 45 days (say, 60 days), then it shall be restricted to 45 days and due date shall be ascertained accordingly.

Non Applicability

This section is not applicable on the following persons:

• If the supplier is not registered under MSMED Act,
• If the supplier is registered under the category of Medium Enterprise,
• If the supplier is registered under the category of 'Traders' under MSMED Act
• If the assessee files the Income tax return under presumptive taxation i.e. section 44AD, 44ADA, 44AE

The Impact

The 'buyer' who is not able to perform the payment to the supplier of goods or services as a company enrolled as a micro or small enterprise, will have to bear the consequences through the new insertion of Finance bill 2023 vide clause (h) of Section 43B moreover to the compensatory interest liability as levied through the section 16 of MSME Development Act, 2006 and is indeed an ineligible business expense. The following may be the impact -

• In case the business enterprise not make payment to Micro, Small and Medium Enterprises in above prescribed period, then it has to make payment of compound interest at monthly rests to supplier at 3 times Bank Interest as same is notified by RBI.
• The interest payable amount or paid through any buyer under the provision of Section 23 of MSME Development Act, 2006, will not be for the purposes of the calculation of the income under the income tax act 1961 permitted as a deduction.
• In case outstanding payments is not made within prescribed time, then that outstanding payable amount shall be added to taxable income of Taxpayer & That Taxpayer has to bear Income tax liability on respective outstanding amount. The Assessee gets deduction in previous year where payments is made.

Illustration

* In terms of Sec. 15 of the MSMED Act, payment terms cannot exceed 45 days.

* Also in case of no agreement Payment Terms are restricted to 15 Days.

To Do's

As the March 31 fiscal year end nears, many companies in India with unsettled dues to manufacturing 'micro and small' vendors will confront higher taxes in the Assessment Year 2024-25 due to the new Clause (H) inserted in Section 43B of the Income-tax Act, 1961 by the Finance Act passed in 2023.

The enterprise may consider the following steps –

• Obtain a valid MSME UDYAM registration.
• Quote its registration number on all invoices and mention its status as 'micro' / 'small' enterprise, as may be applicable.
• Specify payment terms such as 'Payment within 3/5/10 days from presentation of invoice/completion of service/delivery of goods' on the invoice.
• Send a letter to its customer as per format attached if the payment is not received within the stipulated date.

Enclosures:

• Illustrative scenarios capturing allowability as per Sec 43B(h)
• Draft Letters for Customers

Conclusion: Section 43B(h) 'A Thumbs Up' or 'A Compliance Burden' for the MSME Sector?

India's mercantile accounting system sees businesses typically book expenditures when they are incurred or accrued, which occurs after the receipt of goods and services, even if the actual payment occurs later. However, under the MSMED Act and section 43B(h) of the Income-tax Act, the time limit for payment to MSME enterprises is 15 days, or a maximum of 45 days if there is a written agreement between the buyer and the seller. Additionally, several other laws have outlined provisions for the timely payment of dues to such enterprises.

Hence, a company that settles outstanding dues (pending over 45 days as of March 31, 2024) and pays the vendor well after April 1, 2024, can claim the purchase as a deduction in the FY 2024-25 accounts but not in FY 2023-24. Limiting the credit period to 45 days in an environment where it typically extends from 90 to 180 days will necessitate a shift in business operations to expedite cash flow. As The Economic Times reports on this issue, the tax compliance may trigger a fundamental change in how money is managed and deals are negotiated in the trade sector in India. In what has become standard practice, master distributors typically receive goods from manufacturing MSME units and subsequently await payments from their customers, often small and medium businesses. This process often leads to delays in the eventual payments made to the MSME unit.

In securing the MSME's interests the government's intention is justifiable, the same provision must not influence the genuine business transactions. The quality or the nature of the goods or services determines the product value or service also it relies on the demand and the supply for the same. From the present business information, various big business houses are initiated to return or reject the goods to prevent the complications that shall affect the MSMEs to a great extent which is a Bane for the MSMEs. But in some cases it must pay heed to the genuine Agreements in which the payment is bound to delay the limit imposed.

However, since this is the first year of implementation its widespread result will be seen in the years to come.