Payment to MSMEs in 45/15 Days: Section 43B(h) Explained

Introduction: The Finance Act, 2023, introduces significant changes with the insertion of clause h in section 43B of the Income Tax Act, strengthening the enforcement of MSME payment regulations. This analysis dives into the implications for small businesses, examining the provisions of the Income Tax Act, 1961, and the MSMED Act, 2006. Particularly, section 43B(h) is explored, addressing the disallowance of expenses for payments not made within the specified time limit. The article delves into the definitions of micro, small, and medium enterprises (MSMEs) and the crucial payment periods outlined in the MSMED Act.

With insertion of clause (h) in section 43B by the Finance Act, 2023 the provisions of MSMED, Act 2006 have been given a strong enforcement with regards to payment of small businesses. The analysis of provisions of Income tax Act, 1961 & MSMED Act, 2006 is done as under:

Section 43B(h) reads as under:

3B. Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

“….

(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), shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him :..”

The above clause disallows expenses which are not paid in time to the MSMEs within the time limit mentioned in section 15 of MSMED Act, 2006. Therefore for outstandings as on 31st March if payment is not made in the time limit then such expenses shall be disallowed under section 43B(h) from the computation of income. Allowance shall be done in the year in which payment is made.

The definitions of micro and small enterprises is also to be referred from section 7 of the MSMED Act, 2006. Lets go through the provisions of MSMED Act, 2006 below:

Definition of MSMEs-

“Section 7 : MSME Definition

(1) Notwithstanding anything contained in section 11B of the Industries (Development and Regulation) Act, 1951 (65 of 1951),the Central Government may, for the purposes of this Act, by notification and having regard to the provisions of sub-sections (4) and (5), classify any class or classes of enterprises, whether proprietorship, Hindu undivided family, association of persons, co-operative society, partnership firm, company or undertaking, by whatever name called,–

(a) in the case of the enterprises engaged in the manufacture or production of goods pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951 (65 of 1951),as–

(i) a micro enterprise, where the investment in plant and machinery does not exceed twenty five lakh rupees;

(ii) a small enterprise, where the investment in plant and machinery is more than twenty-five lakh rupees but does not exceed five crore rupees; or

(iii) a medium enterprise, where the investment in plant and machinery is more than five crore rupees but does not exceed ten crore rupees;

(b) in the case of the enterprises engaged in providing or rendering of services, as–

(i) a micro enterprise, where the investment in equipment does not exceed ten lakh rupees;

(ii) a small enterprise, where the investment in equipment is more than ten lakh rupees but does not exceed two crore rupees; or

(iii) a medium enterprise, where the investment in equipment is more than two crore rupees but does not exceed five crore rupees.

(Amended in limits on 01/06/2020)

The classification of Micro, Small and Medium Enterprises is defined under the MSMED Act 2006 amendment dated 01/06/2020. The Micro, Small and Medium Enterprises is based on the Investment in Plant, Machinery or Equipment values (excluding land and building) and Annual Turnover. This shall come into effect from 01.07.2020.

• • Micro Enterprise: Where the investment in Plant and Machinery or Equipment does not exceed one crore rupees and turnover does not exceed five crore rupees.
  • Small Enterprise: Where the investment in Plant and Machinery or Equipment does not exceed ten crore rupees and turnover does not exceed fifty crore rupees.
  • Medium Enterprises: Where the investment in Plant and Machinery or Equipment does not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.”

So from the above definition it is clear that the definitions of MSME units is linked to their turnover and investment in plant and machinery. It is suggestive to prepare a list of vendors who fall under the above definition. Kindly note that section 43B(h) does not applies to Medium Enterprises.

Payment period as per MSMED Act, 2006

 The payment period is defined in section 15 as under:

 “Section 15: Liability of buyer to make payment.

 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 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.”

The above section can be summarised as:

1. If there is an agreement: Agreement date or 45 Days Whichever is Earlier

2. If there is no Agreement: 15 Days (Appointed date is defined as 15 days in section 2(b) of the MSMED Act, 2006)

Other Provisions as per MSMED Act, 2006

Interest on payment not made in above time limits

“Section 16 Date from which and rate at which interest is payable.

Where any buyer fails to make payment of the amount to the supplier, as required under section 15, the buyer shall, notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the Reserve Bank.”

If payments are not made to the MSME in above time limit then interest is payable @ 3 times the bank rate notified by RBI. Currently the bank rate is 6.75% declared by RBI which can be viewed on https://rbi.org.in/ home page.

As per section 22 of the MSMED Act, 2006 where the buyer is subject to audit under any law then he is required to furnish the amount of dues to MSMEs, unpaid/paid interest etc.

Further as per Section 23 the interest paid or payable is not allowed as expenditure in the computation of income. This is notwithstanding to anything contained in Income tax Act, 1961.

To Sum Up

1. What if Payment is not made within time limits of 45/15 Days?

• Interest is applicable @ 3 times the bank rate notified by RBI to be paid to the supplier.
• Interest is disallowed under the Income tax Act, 1961 as per Section 23 of the MSMED Act, 2006.
• For outstandings as on 31^st March if payment is not made in the time limits mentioned above, disallowance of expense under section 43B(h) in that year. Allowance to be done in the year in which payment done.

2. Example for Year FY 2023-24 (It is assumed that 45 days’ time limit is applicable)

3. Whether traders are Covered under Section 43B(h) ?

Extract of Office Memorandum of Ministry of Micro, Small & Medium Enterpirses dated: 02/07/2021

(Link: https://taxguru.in/corporate-law/government-announces-inclusion-retail-wholesale-trades-msmes.html)

“.. 2. The Government has received various representations and it has been decided to include Retail and wholesale trades as MSMEs and they are allowed to be registered on Udyam Registration Portal. However, benefits to Retail and Wholesale trade MSMEs are to be restricted to Priority Sector Lending only. ….”

Hence only manufacturers and service providers are covered for the purpose of clause 43B(h) of the Income tax Act, 1961.

4. Disallowance under Section 40(a)(ia) and 43B(h) Simultaneously

If TDS is not deducted and payment also not made within time limit then disallowance under section 43B(h) and not 40(a)(ia).Reason being since no deduction is being claimed hence 40(a)(ia) is not applicable.

5. Applicability of 43B(h) in case of ITR filed under section 44AD or 44ADA

No disallowance, since section 44AD & 44ADA is overriding to sections 28 to 43C. Hence this clause is not applicable to business filing returns under section 44AD or 44ADA.

6. Applicability of 43B(h) in case No tax Audit upto turnover of 10 Crores.

Section 43B(h) still applicable, effect to be taken in computation of Income.

7. I’m a Micro or Small Enterprise will this section apply to me?

Yes these conditions will also apply to the micro and small enterprises who purchase goods/ services from other micro & small enterpirses.

8. Other points

i. Collect MSME certificates from all vendors.

ii. Prepare a list of vendors with MSME certificates.

iii. Execute agreements or issue Purchase orders mentioning terms of payment.

iv. Ensure timely payment as per the above guidelines.

v. Mention your MSME Udyog aadhar no. on all invoices.

Conclusion: In conclusion, the intersection of section 43B(h) of the Income Tax Act and the MSMED Act, 2006, establishes a stringent framework for MSME payment enforcement. Small businesses must navigate these regulations diligently, ensuring compliance with payment periods and interest provisions. The comprehensive analysis provided here serves as a guide for businesses to understand, implement, and align with the amended regulations, securing their financial practices and relationships with MSME vendors.