Section 43B concerning MSMEs, its possible effect & suggestions

In this article I have discussed recent amendments in Section 43B of the Income Tax Act, 1961 proposed to be made by Finance Bill,2023 concerning MSMEs, its possible effect, and certain suggestions.

Finance Bill 2023 and MSMEs

One of the major problem being faced by the MSMEs entities is not-getting their dues from their buyers on a timely basis. To solve this problem government has taken various steps which include revamping the process of registration as MSME, MSME SAMADHAAN, TReDS, etc.

In this quest, mandatorily filing of form MSME Form-1, and change in the format of financial statements of the companies to include disclosure of the amount due to MSMEs creditors, are some of the steps taken by the Central Government.

As a step further in this direction, now Section 43B of the Income Tax Act, 1961 (“IT Act“) has been amended to provide a deduction of the sum payable to Micro Enterprise or Small Enterprise (“MSME“) otherwise allowable only on a payment basis.

As per this amendment, any sum payable by an assessee to MSME supplier beyond the time limit specified in section 15 of the Micro Small and Medium Enterprises Development Act, 2006 (“MSMED Act“) shall be allowed as a deduction in the year in which actual payment has been made.

Section 15 of the MSMED Act requires a buyer to make payment to an MSME supplier on or before the date agreed upon in writing, or where there is no agreement, before the appointed day. It also provides that the period agreed upon in writing shall not exceed forty-five days from the day of acceptance or the day of deemed acceptance.

The appointed day has been defined by Section 2(b) of the MSMED Act as the day following immediately after the expiry of the period of fifteen 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 and the day of deemed acceptance has been defined as a day of actual delivery of goods or rendering of services. In case there is any defect or issue in the delivery of goods or the rendering of services and an objection has been made in writing by the buyer within fifteen days, the day of acceptance shall be the day on which the objection is removed by the supplier.

So, if a buyer is entering into an agreement with an MSME supplier, the due date of payment cannot exceed 45 days from the date of actual delivery of goods or rendering of services as the case may be.

Where there is no written agreement, the due date will be the 16th day of actual delivery.

Possible effect of amendment in Section 43B of Income Tax Act

1. Disallowance u/s. 43B of the Act will be attracted in case the supplier is either Micro Enterprise or Small Enterprise. Disallowance u/s. 43B of the Act will not be attracted if the supplier is Medium Enterprise.

2. Disallowance u/s. 43B of the Act in respect of an amount payable to MSMEs suppliers will not be attracted if the amount payable to MSMEs suppliers is cleared before the end of the financial year. Purchase on 1st April 2023 and payment on 31st March 2024, will not attract disallowance u/s. 43B of the Act. However, the liability of interest as per Section 16 of the MSMED Act will still be there which is not an allowable deduction under IT Act as per Section 26 of the MSMED Act.

3. Purchase on 16th March 2024 may attract disallowance u/s. 43B of the IT Act if payment is not cleared before the end of that financial year. (Provided no due date has been agreed in writing).

4. In case expense has not been claimed on purchase from MSMEs suppliers then disallowance u/s. 43B of the Act shall not be attracted. In case the purchase of goods or services has been capitalized, in my view, there will not be any disallowance u/s. 43B of the IT Act.

5. There may be a situation where some defect in the goods or deficiency in the provision of service is noticed and an objection is made by the buyer, in this situation, the due date shall be counted from the date when objection is removed by the MSME supplier. However, the objection is required to be made in writing by the buyer to the supplier.

6. As per O.M. 5/2(2)/2021-E/P & G/Policy dated 02-07-2021, wholesale and retail trader are entitled for Udyam registration only for the benefit of Priority Sector Lending only. So, purchase from traders would be outside the purview of these amendments.

7. There may be a situation that an assessee issues a cheque to the MSME supplier and due to some reason MSME supplier don’t encash it within the due date. In my view, in light of the judgment of Hon’ble High Court of Punjab and Haryana in case of CIT v. Hindustan Wire Products Ltd. [2002] 120 Taxman 744 (Punjab & Haryana), disallowance u/s. 43B of the Act should not be attracted.

8. A situation may arise that a MSME creditor can also be debtor for the same assessee, whether set-off the liability towards creditor from receivable amount would tantamount to payment? In this respect Hon’ble Jharkhand High Court in the case of CIT v. Shakti Spring Industries (P.) Ltd. [2013] 219 Taxman 124/39 taxmann.com 19, while interpreting the term “actual payment” stated that For making “actual payment” it is always not necessary that one should, if having a credit entry, also have a debit entry, then he should receive the “actual payment” in cash or through cheque or demand draft in his bank account so as to take physical delivery of the currency and then deliver it again to the same creditor who is also debtor of the receiving person. So, “actual payment” means “actual payment” and not actual receipt and delivery of the currency by the two parties transacting when they are creditor and debtor both.

Thing to do for due compliance of Section 43B of Income Tax Act

To avoid disallowance u/s. 43B of the IT Act, an assessee needs to take care following issues: –

1. A declaration of MSME status along with Udyam registration certificate should be taken from suppliers. Master data of suppliers in the accounting software is required to be updated.

2. Where no communication is received from the supplier concerning its MSME status even after proper efforts, then a copy of necessary communication with supplier should be kept in the documentation. In this situation, in my view, provisions of Section 15 of the MSMED Act and Section 43B of the IT Act will not be applicable.

3. Payment terms should be expressly decided in light of Section 15 of the MSMED Act. Payment terms may vary transaction-wise, which can be mentioned in the purchase order. Accounting software should be able to provide reminder of due date of each transaction separately.

4. In case any defect in goods or deficiency in service is noticed, then an objection in writing should be made within 15 days. Date of removable of objection by the vendor should also be kept in record as counting of due date will start from this date.

5. Presently, a general remark is mentioned in the financial statements and tax audit reports that information about MSME status of its suppliers is not available. Guidance Note on Tax Audit us. 44AB of the IT Act,2022 also provides to do the same to Tax Auditors in clause (a) of Para 42.7. This practice, in my view, will not be viable in future as the department may enquire about the MSME status of creditors and try to make disallowance u/s. 43B of the IT Act.

6. Having information of the MSME status of suppliers, a person will also need to make compliance of Sections 16, 22, and 23 of the MSMED Act.

Possible Impact on MSMEs of Section 43B of Income Tax Act

If we look at this amendment from the perspective of the Central Government, this amendment appears to be a beneficial provision for the MSMEs. This will help them to have more liquidity in hands of MSMEs. The availability of more liquidity will help MSMEs to be more competitive. Atleast, PSUs, which are sitting on a large chunk of the due amount of MSMEs, will start making payment to the MSMEs on a timely basis. A

MSME buyers are not exempted from the purview of these amendments. In some industries due date of payment is more than 45 days. MSME buyers of such industries would need more capital in their hand to comply with these amendments. Further non-compliance of Section 43B of the IT Act may result into major tax liability for MSME buyers.

Further, some entities might not prefer to deal with MSME vendors, if it requires them to do additional compliance with legal requirement such as filing of MSME-1, payment of interest which is not an allowable expense, fears of disallowance u/s 43B, etc.

So, these amendments may have positive as well as negative impacts which will depend upon the type of industry and exiting competitiveness of the MSME vendor itself.

Suggestions related to Section 43B of Income Tax Act

Intention of the Central Government to provide benefit to MSMEs cannot be questioned at all, but possibility of negative impact of these amendments on MSMEs cannot be denied. Below are some suggestions which in my view would be helpful: –

1. Provision to encourage early payment to MSMEs can be in form of some incentive. An additional deduction like 80JJAA of the IT Act or a lower rate of tax can be allowed to entities who make a substantial purchase from MSMEs and pay them timely.

2. Disallowance u/s. 43B of the IT Act might have major impact on the financial condition of an assessee who itself is an MSME. MSME buyers should be exempted from the purview of these amendments. A threshold based on turnover can be provided to not expose the small scale enterprises towards this amendment.

3. Currently, specified persons under sections 206AB and 206CCA of the IT Act can be checked on the insight portal of the income tax department. A similar facility can be provided to check the MSME status of suppliers.

Conclusion: –

Compliance of this amendments will certainly require additional attentiveness while dealing with MSMEs. Non-compliance of these amendments may result into huge tax liability for an assessee. Proper internal-mechanism needs to be placed by a taxpayer for proper compliance of this amendment.