Introduction: Navigating the complexities of timely payments to MSME vendors is crucial for businesses to maintain compliance and optimize their financial operations. The Micro, Small, and Medium Enterprises Development (MSMED) Act, along with amendments proposed in the Finance Bill, 2023, underscores the importance of adhering to specified payment timelines to MSMEs. This legislative framework aims to protect the interests of MSMEs by ensuring they receive payments within a defined period, thereby enhancing their cash flow and financial stability. The insertion of a new clause in Section 43B of the Income Tax Act as per the Finance Bill, 2023, marks a significant shift in how businesses must approach their payment schedules to MSME vendors, linking timely payments directly to tax deduction eligibility. This discussion delves into the intricacies of this provision and its practical implications for corporates, non-corporates, and government departments, emphasizing the necessity of understanding and complying with these legal requirements to foster a supportive ecosystem for MSMEs.
Corporates, Non-corporates or government department all are procuring major part of services or goods from the MSMEs. There are provision under the Micro, Small, and Medium Enterprises Development (MSMED) Act, to ensure that businesses make payments to MSMEs within a specified time frame, and failure to which can impact the deduction claims for such payments.
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 Bill, 2023 proposed to insert a new clause (h) in section 43B of the Act to provide that any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the MSMED Act shall be allowed as deduction only on actual payment.
Section 15 of the MSMED Act provides
“In case of written agreements payments due to MSMEs should be made within time frame, agreed-upon 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 provides that deduction for certain sums specified in its clauses (a) to (g) are allowable only on actual payment. However, the Proviso to this section allows deduction on accrual basis if the specified sum is paid by due date of furnishing of the return of income. The Section and the proviso thereto read together provide that deduction is allowable if the actual payment is made by the due date of furnishing the return of income. But so far as the sum covered by the proposed clause (h) is concerned, the payment of the principal sum due to a Micro and Small Enterprise must be made within the time limit specified in section 15 of the MSME Act so as to qualify for deduction.
Let us take a look at some practical situations that outline the eligibility to claim deduction for MSE vendor payments as per the new clause addition. For the following illustration, it is assumed that there is predefined written agreement.
Illustration 1: Kumar & Sons made a payment of expense incurred in PY 2022-23 to a MSE after the time limit set by section 15 of the MSMED Act, 2006, but within the same financial year i.e. before 31st March 2023.
In this situation, Kumar & Sons settled the payment after the specified time limit of Section 15 of MSMED Act, 2006. But the payment was made within the same financial year that the expense was accrued, deduction shall be allowed in that financial year 2022-23.
Illustration 2: Y & Co. completes payment to a MSE within the time limit specified under section 15 of the MSME Act, 2006 and during the same financial year that the expense is accrued.
The provisions of section 43B of the Act would not apply to the payment that Y & Co. made to the MSE. Deduction is allowed in the financial year in which the expense was accrued.
Illustration 3: Z Ltd dealt with an MSE where he had expenses that accrued in March 2024, but amount paid to the vendor during the subsequent financial year in April 2024, within the time specified under section 15 of the MSMED Act, 2006.
In this situation, Z Ltd. made the payment as per the time limit specified under section 15 of the MSMED Act, 2006. Thus, the payment will be allowed as deduction while taxable income is calculated on an accrual basis in the financial year 2023-2024.
Illustration 4: A Ltd. had an expense payable to an MSE that accrued in the financial year 2023-2024 but payment settled in the subsequent financial year 2024-25 after the time limit prescribed under section 15 of the MSMED Act, 2006.
In this case, as the payment is made beyond the time limit as prescribed under section 15 of the MSMED Act 2006 and also in the subsequent year 2024-25, A Ltd. will not be eligible for deduction of the said payment in the financial year 2023-2024 when the expenses accrued. The deduction of this payment allowed in FY 2024-25 in which it is actually paid.
Illustration 5: XYZ Ltd. dealt with an MSE where it received invoice dated 15 March 2024 with respect to supply of goods delivered on the same day. XYZ Ltd. having an issue with regards to the quality of goods supplied, communicated the same to MSE vendor on 18 March 2024. Both the parties reached a conclusion with regards to the dispute on 30 April 2024 and accordingly XYZ Ltd. made a payment on 31 May 2024.
In this scenario, as dispute with regards to the invoice was communicated within 15 days of the date of delivery therefore time limit under section 15 of the MSMED Act 2006 is applicable from the date on which dispute is resolved. And accordingly as the payment is made within 45 days, from the date on which dispute was resolved. XYZ Ltd. will be eligible for deduction of the said payment in the financial year when the expenses accrued.
Payment of Interest to MSMEs:
Section 23 of the MSMED Act provides that where as assesse is liable to make payment of an interest, under or in accordance with the provisions of MSMED Act, no deduction shall be allowed to assessee for such payments for calculating taxable income under Income tax act. As payment of such interest is considered as penal in nature, no deduction is allowed under section 37 of the Income Tax Act.
It is critical to adhere the relevant regulation and requirement under the income tax and MSMED act. Non-compliance of law may lead to disallowance of the expenses and increase the tax burden under the Income tax act. It is advisable to take professional help to check the compliance to avoid repercussions.
Conclusion: The integration of the new clause in Section 43B of the Income Tax Act, as proposed by the Finance Bill, 2023, brings to the forefront the criticality of timely payments to MSME vendors. This legislative adjustment not only protects the financial interests of MSMEs but also mandates a structured approach for businesses in managing their payables. By linking the eligibility for tax deductions to the punctuality of payments, the law encourages businesses to re-evaluate their payment processes and ensure compliance with the MSMED Act’s provisions. This change serves as a reminder of the government’s commitment to strengthening the MSME sector, a vital component of the economy. For businesses, this means adopting more diligent payment practices, potentially requiring adjustments to their financial planning and operations. Ultimately, this move towards ensuring timely payments to MSMEs is expected to foster healthier business relationships, improve the financial health of MSMEs, and contribute to a more robust economic environment. Businesses are advised to seek professional guidance to navigate these regulations effectively, ensuring compliance and leveraging the intended benefits of these legislative measures.
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