“Explore the implications of the Finance Act 2023 amendment under Section 43B of the Income Tax Act, affecting deductions for payments to MSMEs. Learn the impact on tax planning and compliance.”
Deduction of payment to MSMEs
In a bid to facilitate timely payments to micro, small, and medium enterprises (MSMEs) and address the challenges faced by these businesses in recovering their dues, the Finance Act 2023 introduced a significant amendment under Section 43B of the Income Tax Act. This amendment aims to ensure that businesses make payments to MSMEs within a specified time frame, while also impacting the deduction claims for such payments.
Section 15 of the Micro, Small, and Medium Enterprises Development (MSMED) Act, as incorporated by the Finance Act 2023, mandates that payments due to MSMEs should be made within the agreed-upon time frame between the parties, which cannot exceed 45 days. In the absence of a written agreement, these payments must be made within 15 days from the due date.
Section 43B of the Income Tax Act outlines certain expenditures or payments for which deductions can only be claimed in the year when the actual payment is made, regardless of when the liability was incurred. However, if the taxpayer follows the mercantile system of accounting, deductions for such expenses can be claimed if the payments are made before the due date of filing the income tax return under Section 139(1) of the Income Tax Act. This provision applies to all specified payments except for payments made to MSMEs. In other words, if a payment owed to an MSME as of March 31st of the previous year is not made within the prescribed 15 or 45-day period but is paid before filing the income tax return, it cannot be claimed as a deduction in the previous year when the liability was incurred.
With the enactment of the Finance Act 2023, payments due to MSMEs now fall within the scope of Section 43B(h) of the Income Tax Act. Consequently, any payments to MSMEs made beyond the time limits specified in Section 15 of the MSMED Act 2006 can only be claimed as deductions when they are actually paid. Therefore, if a payment to an MSME is made beyond the time limits set by the MSMED Act but before filing the income tax return, the deduction can be claimed in the year of actual payment rather than the year in which the liability was incurred.
This amendment will come into effect from April 1, 2023, and will have a significant impact on businesses’ tax planning strategies, encouraging them to make timely payments to MSMEs and ensuring compliance with the provisions of the MSMED Act. By streamlining payment processes and incentivizing businesses to meet their payment obligations, this amendment seeks to promote a healthy business ecosystem and support the growth of MSMEs in the country.
It is crucial for businesses to be aware of this amendment and adjust their financial practices accordingly to remain compliant with both the Income Tax Act and the MSMED Act, thereby contributing to the sustainable development of the MSME sector.
For better understanding of this clause, below is an example and different situations giving the time of liability incurred.
As on 31st March 2024, ABC Ltd has a liability of Rs 10 lakh to be paid to XYZ ltd. XYZ Ltd is a business registered as Micro, Small and Medium Enterprise (MSME).
| Sr No | Date of incurring liability | Treatment of such liability |
| 1. | Liability is incurred by ABC Ltd on 10th January 2024 | Rs 10 lakh shall be disallowed as deduction to ABC Ltd as the period of 45 days expired on 24th February 2024 |
| 2. | Liability is incurred by ABC Ltd on 14th February 2024 | Rs 10 lakh shall be disallowed as deduction to ABC Ltd as the period of 45 days expired on 31st March 2024 |
| 3. | Liability is incurred by ABC Ltd on 16th March 2024 | In this case, the period of 45 shall expire on 30th April 2024. Accordingly, if the payment is made:
i. On or before 30th April 2024, the deduction of Rs 10 lakh shall be allowed to ABC Ltd in FY 2023-24. ii. After 30th April 2024, the deduction of Rs 10 lakh shall be allowed to ABC Ltd in FY 2024-25 or the year in which the payment is actually made. |
| 4. | Liability is incurred by ABC Ltd on 31st March 2024 | In this case, the period of 45 shall expire on 15th May 2024. Accordingly, if the payment is made:
iii. On or before 15th May 2024, the deduction of Rs 10 lakh shall be allowed to ABC Ltd in FY 2023-24. After 30th May 2024, the deduction of Rs 10 lakh shall be allowed to ABC Ltd in FY 2024-25 or the year in which the payment is actually made. |
Thus for the businesses to claim deduction of any payments due to the vendors, shall have to identify the businesses / vendors to which the payment is due, and are registered as MSMEs. Businesses shall continue to ensure that payments due to MSMEs are made as per the actual agreement between them which is not more the 45 days. In case where no such agreement is entered into, payments are made within 15 days from the date such liability is incurred. The idea to include Section 15 of MSMED Act 2006 under the purview of Section 43B of the Income Tax Act was to promote timely payments to MSMEs. However, this provision cannot fully suffice the same as the assesses may continue to delay the overdue payments to MSMEs which were incurred in the previous year and also claim deduction by making such payment after 45 days from the date on which the liability was incurred but before 31st March of the previous
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