Compliance Challenges & Ramifications of Section 43B(h) of Income Tax Act

Introduction:

The Finance Act of 2023 introduced a significant modification by incorporating subsection (h) into Section 43B, placing a strong emphasis on fostering expeditious payments to Micro and Small Enterprises (MSMEs). Within the Finance Bill 2023 Memorandum, this amendment was highlighted as a key component of Socio-Economic Welfare Measures, specifically aimed at enhancing the punctuality of payments to Micro and Small Enterprises. Additionally, it is explicitly stated that the aforementioned revision is slated to come into effect on April 1, 2024, thereby becoming applicable to the Assessment Year 2024-25 and subsequent fiscal years. This legislative change underscores the government’s commitment to promoting the well-being of MSMEs through initiatives that address timely financial transactions and support the socio-economic welfare of this vital sector.

What is the new Amendment:

Section 43B of the Income Tax Act- Certain deductions to be only on actual payment:

“(h) 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 Act, 2006 (27 of 2006).”[1]

Section 15 of the MSME Development Act, 2006 defines that:

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

Provided that in no case the period agreed upon between the supplier and the buyer in writing shall not exceed forty-five days from the day of acceptance or the day of deemed acceptance”[2]

It is clear from the amendment that it applies only to micro and small enterprises, so let’s first understand which enterprises come under micro and small enterprises:

Micro enterprises:

(a) Investment in plant and machinery should not exceed 1 crore.

(b) Turnover should not exceed 5 crores

Small enterprises:

• Investment in plant and machinery should not exceed 10 crores
• Turnover should not exceed 50 crores.

Analysis of the section:

• There are specific stipulations that businesses are required to adhere to in terms of payment to small and micro suppliers. The designated time frames for such payments are set at either 15 or 45 days.
• Failure to make the payment within the prescribed period will result in the inclusion of the outstanding amount in the taxable income of the business.
• In instances where no formal agreements are in place, it is mandated that payments be completed within a 15-day window.
• However, if a written agreement exists, the business is obligated to fulfill the payment obligations in accordance with the terms outlined therein, with the maximum allowable duration for such agreements being capped at 45 days.
• These regulations serve to ensure timely and fair compensation for small and micro suppliers while imposing tax-related consequences for non-compliance with the

Challenges and consequences of the said amendment:

• The mentioned amendment is likely to create timing discrepancies and influence deferred tax adjustments. For Example, If an assessee fails to settle dues to SMEs within the stipulated timeframe outlined in Section 15 of the MSMED Act for a specific month, let’s say April, but makes the payment before the end of the respective financial year on 31st March, can they still qualify for a deduction?[i]
• The payment made after March 31, even if it exceeds the specified time limit of 15/45 days, will be disallowed, unlike other payments mentioned in Section 43B of the Income-tax Act 1961. Nevertheless, the said payment will be permissible in the subsequent financial year.
• Apart from this, There is a lack of clarity regarding payments executed by government departments, and these entities could potentially be significant contributors to defaults.
• After the amendment, disallowance will occur solely due to non-payment without even considering the authenticity of the purchase.
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• Another aspect deserving consideration is that this amendment will have no bearing on assesses who utilize goods or services from SMEs, wherein the expenses are not recorded in the profit and loss account but are instead treated as an asset in the financial statements. This provision is not applicable to such payments, rendering them ineligible for any associated benefits.
• The aforementioned provision is exclusively applicable to MSMEs that are registered under the MSME Act of 2006. Consequently, MSMEs lacking such registration will not be entitled to the advantages associated with timely payments as outlined in this clause.
• It is imperative for businesses to establish effective systems for monitoring payments and guaranteeing adherence to regulations. Numerous transactions may potentially escape notice without such robust mechanisms in place.
• Deferred payments could also result in increased tax obligations, potentially influencing future profit margins.
• The businesses may face reputational damage due to delayed payments which might affect customer relationships and brand image.
• Clear guidelines to address potential disputes regarding the applicability of the clause are currently lacking.

Conclusion:

In light of the aforementioned discourse and taking into account the feasibility of the proposed amendment, it is discerned that while the government’s commendable intention to bolster the Small and Medium-sized Enterprise (SME) industry is recognized, the tangible advantages emanating from this amendment may not effectively address the liquidity challenges faced by SMEs. It is anticipated that taxpayers may be reluctant to disrupt their credit cycles in response to a disallowance in the computation of income tax, which essentially constitutes a timing difference. Consequently, the anticipated impact of this amendment on SMEs appears to be less significant, and there is a likelihood that the Micro, Small, and Medium Enterprises (MSME) sector may not be in favor of the aforementioned amendment.

Hence, the efficacy and practicality of the newly introduced Section 43B(h) raise substantial uncertainties, primarily due to the discernible imbalance between the potential adverse repercussions and the anticipated positive impacts. This inherent imbalance prompts serious reservations about the overall advantage it might confer upon the Micro and Small Enterprises (MSME) sector. The underlying skepticism extends to the characterization of this legislative amendment as an economic social welfare measure, a classification emphasized by the government during the unveiling of the said amendment.

[1] Income Tax Act, 1961, § 43, No 43, Acts of Parliament, 1961(India).

[2] MSME Development Act, 2006, § 15, No 27, Acts of Parliament, 2006(India).

[i] https://www.thehindubusinessline.com/economy/delay-in-making-payment-to-micro-small-enterprises-means-deferred-deduction-for-corporates/article67748944.

ii https://www.voiceofca.in/siteadmin/document/ImplicationsofamendmentinSection43B.pdf

iii https://cleartax.in/s/section-43b-income-tax-act.