The Finance Act 2023 introduced Section 43B(h), which allows deductions for sums owed to Micro and Small Enterprises (MSEs) for goods or services provided, provided they are paid within the time frame specified under the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. This amendment seeks to alleviate working capital challenges faced by the MSME sector and encourage timely payments to small businesses. The change will take effect on April 1, 2024, and apply to the assessment year 2024–2025 and subsequent years.
Definition of MSME as per Micro, Small and Medium Enterprises Development Act, 2006
"According to the Micro, Small and Medium Enterprises Development Act, 2006, MSMEs are classified into three categories:
- Micro enterprise:
An enterprise where the investment in the plant and machinery or equipment does not exceed ₹1 crore, and turnover does not exceed ₹5 crores. - Small enterprise:
An enterprise where the investment in the plant and machinery or equipment does not exceed ₹10 crores, and turnover does not exceed ₹50 crores. - Medium enterprise:
An enterprise where the investment in the plant and machinery or equipment does not exceed ₹50 crores, and turnover does not exceed ₹250 crores."
Meaning of "Investment in Plant and Machinery"
What is the meaning of 'investment' in plant and machinery for the purpose of understanding a 'micro' and 'small' enterprise?
As per RBI/2020-2021/26 - FIDD.MSME & NFS.BC.No.4/06.02.31/2020-211 dated 21 August 2020, the online form for Udyam Registration captures depreciated cost as on 31st March each year of the relevant previous year. Therefore, the value of Plant and Machinery or Equipment for all purposes of the Notification No. S.O. 2119(E) dated June 26, 20202 and for all the enterprises shall mean the Written Down Value (WDV) as at the end of the Financial Year as defined in the Income Tax Act and not cost of acquisition or original price, which was applicable in the context of the earlier classification criteria.
Time Limit for making payment to MSME
According to Section 15 of the MSMED Act, payments to micro and small enterprises must be made within the period specified in the " written agreement ", which cannot exceed 45 days. In the absence of a written agreement, payments must be made within 15 days. Payments made beyond these timeframes will be governed by the newly inserted clause (h) in Section 43B, which stipulates that deductions will only be allowed upon actual payment.
The term "written agreement" is not specified in the Act. An agreement means "an offer made by one person and accepted by another must be accepted by all parties involved" and therefore, even an invoice can be considered as written agreement as it contains all the characteristics of agreement
How does the amendment in Section 43(b) (h) of Income tax Act impact the filing of income tax returns for businesses dealing with micro and small enterprises?
Businesses that engage with micro and small enterprises must be more proactive in tracking and ensuring timely payments to these entities. Since deductions for delayed payments can only be claimed when the payment is actually made, businesses may need to adjust their accounting and tax planning strategies. This could involve revising cash flow management to ensure timely payments or facing tax consequences for delayed payments. The amendment emphasizes the importance of adhering to the payment deadlines outlined in the MSMED Act to claim tax deductions effectively.
Additionally, tax auditors are required to report any unpaid dues to micro and small enterprises in Form 3CD of the Tax Audit Report. The assessee must add back to their total income the disallowance reported in Form 3CD and file the Income Tax Return (ITR) accordingly. If this is not done, the Income Tax Department, through CPC Bengaluru, will add back the disallowance and recompute the tax liability during the ITR processing.
What types of payments are covered by this provision?
The provisions apply to "any sum payable," which includes both revenue and capital expenditures. The implications are as follows:
- If the assessee is claiming the deduction as a revenue expenditure, disallowance under Section 43B(h) will apply for payments made beyond the stipulated date.
- If the assessee is capitalizing the expenditure, the claim for depreciation under Section 32 will be restricted until the payment is made to the seller, due to the overriding effect of Section 43B over Section 32 of the Income Tax Act.
What if the recipient buyer chooses to declare income under presumptive schemes of Section 44AD / 44ADA / 44AE of the Income Tax Act?
The above provisions do not apply if the recipient buyer is reporting profits under the presumptive taxation schemes outlined in Section 44AD, 44ADA, or 44AE of the Income Tax Act. This is clearly stated in the relevant sections, which specify that "notwithstanding anything to the contrary in sections 28 to 43C of the Act."
Whether full payment needs to be made or, even a part payment shall qualify for deduction on payment basis?
Since Section 43B of the Income Tax Act, 1961 mandates deductions on an actual payment basis, a deduction will be allowed for the portion of payment made, even if only part of the payment has been made to a 'micro' and/or 'small' enterprise.
Are 'traders' covered for the benefit of delayed payments?
Vide OM No. 5/2(2)/2021-EIP&G/Policy dated 2.7.20213 issued, "Retail and Wholesale Trades have been included as MSMEs, allowing them to be registered on Udyam Registration Portal and benefits to Retail and Wholesale trade MSMEs are to be restricted to Priority Sector Lending only."
Therefore, transactions involving purchases from traders are excluded from the scope of these amendments. Consequently, any amount payable to a trader creditor will not be subject to the provisions of Section 43B(h).
If a charitable trust makes a payment to an MSME, would Section 43B(h) apply?
Section 43B(h) applies to an assessee engaged in a business or profession, with income computed under the head "Business and Profession." Charitable Trusts are governed by sections 11 to 13 of the Income Tax Act.
Section 11 of the Income Tax Act addresses the computation of income from property held for charitable or religious purposes. Section 11(1) specifies that income will not be included in the total income of a person to the extent it is applied towards charitable or religious purposes in India. It is a well-established principle that the income referred to in Section 11(1) must be computed using commercial principles, rather than under the general provisions of the Act. This means that Section 14 and the five heads of income do not apply to organizations registered under Section 12AB.
Therefore, the issue of disallowance under Section 43B(h) does not arise when calculating the application of income under Section 11 of the Income Tax Act. However, Section 16 of the MSMED Act that is interest payable to MSME on delayed payments may still be relevant.
Consequences for Failure to Make MSME Payments Under Section 43B(h) of the IT Act:
The government has introduced a portal, MSME Samadhaan, to facilitate complaints regarding delayed payments.
- If payments are not made within the prescribed time frame, the outstanding amount will be added to the taxpayer's taxable income, making the taxpayer liable to pay income tax on the respective sum. The taxpayer can claim a deduction in the following year when the payment is eventually made.
- If a buyer fails to make payment to the supplier, the buyer will, regardless of any agreement or law in force, be required to pay compound interest with monthly rests to the supplier on the outstanding amount in accordance with Section 16 of MSMED Act 2006. This interest will be calculated from the appointed day or from the date immediately following the agreed date, at a rate three times the bank rate notified by the Reserve Bank of India.
Ways for Large Business Houses to Streamline MSME Vendor Management:
- Require MSME vendors to include their registration number on all documents such as bills, invoices, and business correspondence.
- Obtain a declaration from all vendors at the start of the year to identify regular vendors and those covered under the MSME category.
- Verify the validity of MSME vendors through the MSME Portal.
- Keep MSME invoices separate and implement a fast-track process from material/service receipt to payment due date, using special coding.
- Separate your Vendor General Ledger (GL) codes into two categories: MSME Creditors and Other Vendors.
- Create a rubber stamp that says "MSME-REGISTERED" and affix it to all bills, ensuring that the payment processing team prioritizes these bills.
- Modify your software to set trigger dates, ensuring payments to MSME vendors are made within the due dates.
Conclusion
In light of the above discussion, adhering to Section 43B(h) of the Income Tax Act is essential for growth of MSME. Making timely payments to small businesses is vital to avoid tax penalties and maximize the advantages of Udyam Registration. This amendment will ensure timely payments to MSME which will positively boost the growth of economy as a whole.
Footnotes
1. RBI/2020-2021/26 https://www.rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=11951
2. Notification No. S.O. 2119(E) https://www.dcmsme.gov.in/IndianGazzate_0.pdf
3. OM No. 5/2(2)/2021-EIP&G/Policy dated 2.7.2021 https://www.dcmsme.gov.in/scan0052.pdf
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