Section 43B(h) Deduction Allowed only on Payment Basis

Introduction: Section 43B(h) of the Income Tax Act, 1961, introduces a significant change regarding deduction allowances specifically related to payments made to Micro and Small Enterprises (MSEs). Understanding its implications, analysis, and compliance requirements is crucial for taxpayers and auditors alike.

Section 43B(h) of Income Tax Act., 1961 : Deduction Allowed only on Payment Base:-

To understand the newly inserted clause h of Section 43B, we need to first understand what is MSME and what is section 43B, I tried to explain the same in simple manner as under:-

Income Tax Provision for delayed payment to Micro & Small Enterprise:-

1. What is Section 43B of IT Act:–

Certain deductions to be only on actual payment

43B. Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

(a) Any sum payable by way of Tax, Duty, Cess or Fee, by whatever name called, under any law for the time being in force, or

(b) Any sum payable by the assesse as an employer by way of contribution to any PF or superannuation fund or gratuity fund or any other fund for the welfare of employees, or

(c) Any sum referred to in clause (ii) of sub-section (1) of section 36 i.e Bonus or Commission for services rendered payable to employees, or

(d) Any sum payable by the assesse as Interest on any loan or borrowing from any public financial institution or a State Financial Corporation or a State Industrial Investment Corporation, or

(da) Any sum payable by the assesse as Interest on any loan or borrowing from deposit taking non-banking financial company or systemically important non deposit taking non-banking financial company, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or,

(e) Any sum payable by the assesse as Interest on any loan or advance from a scheduled bank or co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or

(f) Any sum payable by the assessee as an employer In lieu of earned leave of his employee, or

(g) Any sum payable by the assesse to the Indian Railways for use of Railway assets

Shall be allowed only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him:

Proviso to Sec. 43B

Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee alongwith such return:

Budget Speech to Finance Bill 2023

MSMEs & Professionals:

134. MSMEs are the growth engines of our economy……………… Moreover, to support MSMEs in timely receipts of payments, I proposed to allow deduction for expenditure incurred on payments made to them only when payment is actually made.

And as per the MEMORANDUM EXPLAINING THE PROVISIONS IN THE FINANCE BILL, 2023

B. Socio Economic Welfare Measures

Promoting timely payments to Micro and Small Enterprises

1. Section 43B of the Act provides for certain deductions to be allowed only on actual payment. Further, the proviso of this section allows deduction on accrual basis, if the amount is paid by due date of furnishing of the return of income.

2. In order to promote timely payments to micro and small enterprises, it is proposed to include payments made to such enterprises within the ambit of section 43B of the Accordingly, it is 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 & SMALL ENETERPRISE beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 shall be allowed as deduction only on actual payment However, it is also proposed that the proviso to section 43B of the Act shall not apply to such payments.

3. Section 15 of the MSMED Act mandates payments to micro and small enterprises within the time as per the written agreement, which cannot be more than 45 days. If there is no such written agreement, the section mandates that the payment shall be made within 15 days. Thus, the proposed amendment to section 43B of the Act will allow the payment as deduction only on payment basis. It can be allowed on accrual basis only if the payment is within the time mandated under section 15 of the MSMED Act.

4. This amendment will take effect from 1st April, 2024 and will accordingly apply to the assessment year 2024-25 and subsequent assessment years.

[clause 13]

Further to give clarity for “Micro and Small Enterprise” Explanation 4 of Clause (e) and (g) of the section is also amended as under :-

Expressions “micro enterprise” and “small enterprise”

It is also proposed to substitute clause (e) and clause (g) of Explanation 4 for the purposes of the said section.

To define

‘(e) “micro enterprise” shall have the meaning assigned to it in clause (h) of section 2 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006.);’

‘(g) “small enterprise” shall have the meaning assigned to it in clause (m) of section 2 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006.).’

From the above, question arises that what is micro, Small Enterprise, time limit u/s 15 , Supplier , who covered under the new clause h of section 43B of the Income tax Act.

2. MSMED Act: Some Important definitions relevant to Section 43B(h)

1) What is MSME:-

MSME Stands for Micro, Small and Medium Enterprises.

In accordance with the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, where in enterprises have been classified as under:

Manufacturing Enterprises:-

Enterprises engaged in the manufacture or production of Goods pertaining to any industry.

Services Enterprises:-

Enterprises engaged in providing or rendering of services

As the Contribution of MSME is approximately 40% of Total Export and 30% of India’s GDP., MSMEs is considered as the backbone of the economy, encompassing a wide range of businesses from small startups to established enterprises. Their resilience and adaptability drive economic progress.

 2. MICRO and SMALL ENTERPRISE is define under clause h and m of Section 2 of MSMED Act.

Clause (h) of Section 2

(h) “micro enterprise’ means an enterprise classified as such under sub-clause (i) of clause (a) or sub-clause (i) of clause (b) of sub- section (1) of section 7;

Clause (m) of Section 2

(m) “small enterprise” means an enterprise classified as such under sub- clause (ii) of clause (a) or sub-clause (ii) of clause (b) of sub-section (1) of section 7;

As per Notification no. S.O. 2119 (E) dated 26th June, 2020 reclassified the Micro, Small and Medium Enterprise as per below table:

Section 7 (1) (a) (i) & (ii)

*Exports will not form part of the annual turnover. Either or (Upward) or Both the condition (Downward)

Further Office memorandum dated 2nd July, 2021 of GOI, and Ministry of MSME includes the Retail and Wholesale trade to registered under MSME and Benefits of MSME is restricted to only Propriety Sector lending only.

3. Sec. 2(e): Enterprise:-

(e) “enterprise” means an industrial undertaking or a business concern or any other establishment, by whatever name called, engaged in the manufacture or production of goods, in any manner, pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951 (55 of 1951) or engaged in providing or rendering of any service or services;

Analysis:

1. The enterprise must be engaged in the manufacture or production of goods

2. Therefore an enterprise which is engaged into trading is not covered by the term enterprise

3. Expression “engaged” is not defined in MSME Act, 2006

4. However, in the portal dcmsme.gov.in being the portal belonging to the Government of India the meaning of manufacturing enterprise is explained as “employing plant & machinery in the process of value addition to the final product having distinct name or character or use”.

Thus, a unit engaged in manufacturing or producing an article which is having distinct name or character or use can be stated as an entity covered by the definition.

It has also been used in the sense of being busy or conducting or devoting attention or efforts or employing one self.

The word ‘engaged in the manufacturing, production “ etc should normally.

Entities engaged in manufacturing or production refer to businesses involved in the creation or processing of goods. The MSME Act provides definitions and criteria for classifying enterprises based on their investment in plant and machinery or equipment for manufacturing activities.

4. Section 15 of MSMED Act,2006

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 45 days from the day of acceptance or the day of deemed acceptance.

5. Section : 2 (n) Supplier:

(n) “supplier” means a micro or small enterprise, which has filed a memorandum with the authority referred to in sub-section (1) of section 8, and includes,–

a. the National Small Industries Corporation, being a company, registered under the Companies Act, 1956 (1 of 1956);

b. the Small Industries Development Corporation of a State or a Union territory, by whatever name called, being a company registered under the Companies Act, 1956 (1 of 1956);

c. any company, co-operative society, trust or a body, by whatever name called, registered or constituted under any law for the time being in force and engaged in selling goods produced by micro or small enterprises and rendering services which are provided by such enterprises;

6. Section 2(b): Appointed Date:

“appointed day’ means the day following immediately after the expiry of the period of 15 days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier.

Explanation.–For the purposes of this clause,–

(i) “the day of acceptance” means,–

(a) the day of the actual delivery of goods or the rendering of services; or

(b) where any objection is made in writing by the buyer regarding acceptance of goods or services within 15 days from the day of the delivery of goods or the rendering of services, the day on which such objection is removed by the supplier;

(ii) “the day of deemed acceptance” means, where no objection is made in writing by the buyer regarding acceptance of goods or services within 15 days from the day of the delivery of goods or the rendering of services, the day of the actual delivery of goods or the rendering of services;

Summary of combined reading of Sec. 15 & 2(b) of MSMED Act.,

7. Section 16: if payment is not made within the time limit specified under section 15, then the interest payable shall be three times of the bank rate notified by the RBI. Further it is to be noted that the Interest paid u/s 16 of MSMED Act., 2006 is not allowable interest deduction under the Income Tax Act, 1961.

3. Consequences on default in payment to Micro and Small Enterprise within the specified time limit u/s 15 of MSMED Act, 2006:

The Buyer who fails to make the payment to the supplier of goods or services i.e Registered MICRO or SMALL ENTERPRISE will fall in the ambit of the clause h of Section 43B of the Income tax Act in addition to the compensatory interest liability as imposed u/s 16 of the MSMED Act, 2006 which is also ineligible business expenditure.

1. Compensatory Interest : To Pay Compounded Interest on monthly rest which is 3 times of the bank rate notified by RBI (RBI repo rate)

2. Disallowances of Compensatory Interest paid to MSME: As per Section 23 of MSMED Act, 2006 the amount of Interest payable or paid by the buyer in accordance with section 16 of the MSMED Act, 2006 shall not for the purpose of computation of total income under the IT Act, 1961.be allowed as deduction

3. Disallowances of Expenses : Any sum payable by the buyer for the expenditure incurred or purchases to the registered supplier as a MICRO or SMALL enterprise shall be disallowed if the same is not paid as per section 15 of MSMED Act, 2006

4. To Whom the clause h of Section 43B of the Income Tax Act, 1961 is applied:

The Clause is applicable to all the assessee, for the sum payable to the micro or small enterprises only.

5. Clause h of section 43B of the Income Tax Act, 1961 is applicable from the financial year starting from 01^st April, 2023 i.e Assessment year 2024-2025.

6. As the section 43B is for the expenditure allowed on payment basis, so it is for the expenses/ purchases debited to the profit and loss account for the year 2023-2024 and not the outstanding balance of the registered suppliers of Micro or small enterprises as on 31.03.2023.

Example

–

• Maximum credit period allowed as per MSMED Act, is 45 days if there is written agreement between buyer and supplier of the goods or services.

Executive Summary:-

1. Assessee first need to identify its supplier is micro or small enterprise.

2. Micro or small enterprise must engaged into the activity of Manufacturing or service.

3. Additional Duty to taxpayers as well as auditor.

4. To Check Aging of Creditors as on 31.03.2024 and also section 15 of the MSMED Act.

5. Section 43B is blessing for Micro and Small Supplier & TAX BOMB for buyer who keeps unpaid supplier.

6. Clause is applicable to only micro and small enterprise only. Medium Enterprise is excluded.

7. Traders Registered under MSME is not covered under provision of Section 43B(h) as per the Office Memorandum (OM) No. 1/4(1)/2021-P&G/Policy, Dated: 01.09.2021 which emphasis the benefits to traders are restricted to only priority sector lending only and other benefits of delayed payments as per MSMED Act,2006 are excluded

8. Deduction of expenditure is allowed only on Payment basis only.

9. In absence of specific guidelines, Payment could be adjusted on FIFO basis.

10. Retention money not covered under this clause

11. In an interesting case Hon. Supreme Court has held that the MSMED Act is a special act and overrides any general act like the Arbitration Act. It further held that if the supplier on the date of transaction is not holding the registration/memorandum and is not covered under the MSMED Act, it can’t claim benefits with subsequent registration.

12. Need to take declaration from the supplier indicating that they are micro or small enterprise and registered under MSMED Act, 2006 which helps the buyer as well as auditor to ensure due compliances of this section.

Conclusion: Section 43B(h) introduces a pivotal change in tax deduction allowances concerning payments to Micro and Small Enterprises. Assessees must navigate its implications diligently, ensuring compliance with both the Income Tax Act and the MSMED Act. Understanding the nuances of this provision is essential for tax planning, financial reporting, and regulatory adherence in supporting the growth and sustenance of MSEs in India’s economic landscape.