Understanding Section 43B(h) | Impact on MSME Payments

The Finance Act, 2023 introduced Section 43B(h) in the income tax code, affecting how deductions for payments to MSMEs are calculated. This amendment shifts from accrual to actual payment basis, influencing business practices significantly. New clause (h) of income tax section 43B allows deductions made to MSMEs on an actual payment basis rather than the accrual basis if the payment is created within the threshold limit. This clause comes into effect from 1st April, 2023.

Let us try and understand the critical aspects related to this much talked about amendment in recent times and how it affects the businesses in general.

The relevant bare extract of the clause (h) of Section 43B is as under:

“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.”

What it means is that the assessee (buyer) has to make payments to micro or small enterprises (registered as manufacturers or service providers on UDYAM Portal) for purchase of any goods and/or services within the TIME LIMITS PRESCRIBED in the MSME Act, 2006, in order to claim deduction in the year of incurrence of liability.

It is pertinent to note the criteria for classification of enterprises into micro, small and medium (Amended w.e.f. 01.07.2020):

CLASSIFICATION

MICRO SMALL MEDIUM

Manufacturing enterprises and Enterprises rendering services Investment* in Plant and Machinery or Equipment: Not more than Rs. 1 crore AND Annual Turnover* not more than Rs. 5 crores. Investment* in Plant and Machinery or Equipment: Not more than Rs. 10 crores AND Annual Turnover* not more than Rs. 50 crores. Investment* in Plant and Machinery or Equipment: Not more than Rs. 50 crores AND Annual Turnover* not more than Rs. 250 crores.

Composite criteria to be considered cumulatively.

Liability of the “Buyer” to pay within time limits: As per Section 15 of the MSME Act, 2006, the buyer must pay within 15 days of acceptance/deemed acceptance of goods/services (in case there is no written agreement for payment terms) OR, within the date of written agreement which cannot exceed 45 days from the day of acceptance/deemed acceptance (if there is a written agreement).

On time payments within the above time limits will lead to allowance of expenditure normally on an accrual basis. Furthermore, if the payments are not made within the above time limits but are made within the same Financial Year (FY), the expenditure will still be allowed in the relevant FY.

But, if the payments are not made within the time limits of Section 15 of the MSME Act, 2006, and are actually paid in the next FY, the expenditure will be allowed in the year of payment only and not in the FY in which liability was incurred.

This is where the whole challenge arises for businesses. Except for this clause (h), expenditure under Section 43B was/is allowed in the year of liability on accrual basis if the payments are made on or before the due date of filing income tax returns under Section 139.
But, under clause (h) of Section 43B deduction will be allowed only IN THE YEAR OF PAYMENT if not paid within the time limits and is actually paid in the next Financial Year.

This could have a huge impact on taxability and working capital availability of businesses and business should plan well to avoid adverse scenarios.

This disallowance of expenditure under Section 43B(h) is applicable only when the income of assessee is computed under the head “profits and gains of business and profession” i.e. under Section 28 to Section 44D.

This means Section 43B(h) is not applicable to charitable trusts, societies and NGOs which are registered under Section 12A/12AA of the Income Tax Act and whose income is determined under sections 11 & 12 and not under Section 28 to 44D

But the important point to be taken care of here of is that delayed payments to micro or small enterprises (registered as manufacturers or service providers on UDYAM Portal) will lead to interest liability as prescribed under Section 16 of the MSMED Act, 2006 under all cases and circumstances and applicable to all buyers.

The same will be calculated at three times of the bank rate notified by the RBI, compounded with monthly rests (currently notified bank rate is 6.75%). This could lead to substantial interest liabilities in case of delayed payments to micro or small enterprises. Hence, late payment can have financial implications beyond the Income Tax Act.

Furthermore, this interest on late payments to micro and small enterprises will be disallowed u/s 37, under the Income Tax Act, 1961.
Therefore, there could be massive impacts on the taxability and cash flows of the businesses if payments are delayed beyond permissible time limits.

Overall applicability and impact of Section 43B(h) can be summarized as under:

• The status of buyer of goods and/or recipient of services is irrelevant and status of seller only has to be checked.
• Section 43B(h) is applicable ONLY IF purchases have been made and services have been received from micro and small enterprises which are registered as such on UDYAM Portal.
• This section is applicable only to those sellers who are registered as manufactures or service providers under the MSME Act, 2006. If the seller is registered as a trader Section 43B(h) is not applicable.
• If the sellers are not registered on UDYAM Portal under MSME Act, they will not be covered by this section even though they meet the investment and turnover criteria.
• This section is not applicable to Charitable trusts, societies, companies, NGOs etc. which are registered under section 12A/12AA as their incomes are determined under Sections 11 and 12.
• In my opinion this Section is also applicable to those businesses/professions which are declaring incomes under section 44AD/44ADA/44AE as Section 43B(h) overrides all other provisions of the Act.
• Lastly, delayed payments to MSME registered micro and small enterprises will lead to huge interest liability which will be applicable to all buyers.

Conclusion: Section 43B(h) represents a crucial amendment in income tax law, altering the dynamics of MSME payments. Businesses must grasp its implications, ensuring timely payments to avoid penalties and interest liabilities. Understanding and adhering to these regulations are essential for maintaining financial health and compliance in today’s business landscape.