The Finance Act 2023 added Section 43B (h) to the Income Tax Act. Under it, corporations are entitled to deduct amounts payable to MSEs for goods or services only if they pay within the prescribed time under the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006. In the event of delayed payments, the deduction is permissible only in the year payment is made. This new provision is intended to deal with delayed payments, one of the major issues facing small businesses with cash flow and working capital shortages. Imposing timely payments encourages financial discipline in the MSME sector and ensures small businesses receive timely payment of their dues. The regulation begins on April 1, 2024, and impacts the Assessment Year 2024–25 and subsequent.

1. What is Section 43B(h)?

Section 43B (h) is a new section of the Income Tax Act under the Finance Act 2023. It addresses payments to Micro and Small Enterprises (MSEs) for goods or services rendered by them.

Timing of Reduction Related to Payment

According to this provision, companies are allowed to avail a tax deduction on payments made to MSEs only if the payments are within the period defined under the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006.

Impact on Deduction Timing

Before the amendment, it was acceptable for companies to deduct expenses paid even if payment is postponed, provided that payment is made before the tax return filing date. With Section 43B (h), this advantage is no longer provided for payments made to MSEs. The concession only relies on actual payment within the MSMED Act time frame.

Exclusion from the first half of Section 43B

You can still deduct other expenses found in Section 43B, such as tax obligations and wages paid to employees when you pay them before the tax return due date. However, income tax Section 43B h is not for this ease. It only means that even if the company makes an overdue payment to an MSE before its tax return filing, it cannot deduct the last financial year. Instead, the deduction is postponed to the year the payment is made.

2. MSME Classification and Turnover Limits

Micro Enterprises and Small Enterprises are categorized based on certain financial limits for investment in machinery and tools or equipment and turnover on an annual basis. This is defined in Notification No. 2119(E), dated June 26, 2020, and was issued by the Ministry of Micro, Small, and Medium Enterprises (MSME), Section 7 of the MSMED Act, 2006.

1. Micro Enterprise

A business is a Micro Enterprise if it satisfies both of the following conditions:

• Investment in machinery, equipment, or plant does not exceed INR 10 million (1 crore).
• Annual sales are not more than INR 50 million (5 crores).

2. Small Business

A company is considered a Small Business if it satisfies both of these criteria:

• Plant, machinery, or equipment investment is not more than INR 100 million (10 crores).
• The yearly revenues are not more than INR 500 million (50 crores).

3. Applicability of Section 43B(h)

Section 43B (h) is applicable when a company buys goods or avails services from a supplier who is a Micro or Small Enterprise (MSE) under the Micro, Small, and Medium Enterprises Development (MSMED) Act of 2006.

Suppliers must be registered under the MSMED Act.

For Section 43B (h) to apply, the supplier has to be a Micro or Small Enterprise and should be registered under the MSMED Act, 2006. This implies that even if a company collaborates with an MSME, but the supplier is not registered under the MSMED Act, this provision will not be applicable.

Registration of Buyer under MSMED Act Not Mandatory:

The working of income tax act Section 43b h does not depend on whether the buyer is registered under the MSMED Act. Any enterprise that purchases goods or services from a registered Micro or Small Enterprise shall be obligated to fulfill this requirement, whether or not they are registered under the MSMED Act.

Example of a Scenario:

Mr. A is an unregistered buyer as per the MSMED Act. Mr. B is a registered supplier under the MSMED Act and is selling products to Mr. A. Mr. A owes Mr. B a sum of money. In this case, Section 43B(h) will be applicable since Mr. B (the supplier) is a registered person in terms of the MSMED Act. This indicates that Mr. A can only deduct what he owes Mr. B if it is paid within the MSMED Act, 2006 timeframe.

4. Non Applicability to Traders:

This provision does not cover traders, although they might be Udyam registered for certain benefits. Under Office Memorandum No. 5/2(2)/2021-E/P and G/Policy dated July 2, 2021, of the Ministry of MSME, wholesale and retail traders are not enterprises under the MSMED Act, 2006, for most regulatory advantages. They are registered on Udyam (MSME registration portal) to avail of Priority Sector Lending (PSL) advantages only from banks and financial institutions.

Example of a Scenario

If Mr.A purchases goods from Mr.B, a wholesale trader, registered under Udyam. Then, Section 43 B (h) is not applicable. As traders are not MSEs according to this provision, the buyer, Mr. A, can claim the expense as a tax deduction regardless of when the payment is made.

5. Effective Date Details

Section 43B (h), which has been inserted in the Finance Act, is operative from April 1, 2024. This means the amendment will apply from assessment year (AY) 2024-25, corresponding to the financial year (FY) 2023-24. For instance, Mr. A purchased goods from Mr. B on March 31, 2023. Here, income tax act Section 43b h will not be applicable in the case of payments made up to March 31, 2023. The provision is applicable only for payment for goods and services from April 1, 2024.

6. Payment Time Limits (Section 15 of MSMED Act)

Under Section 43B (h), companies must adhere to specific terms of payment to MSMEs as mandated under Section 15 of the MSMED Act, 2006. The terms of payment are according to a written agreement between the supplier and the buyer.

• No Written Agreement: If there is no written agreement requiring payment, then the payment needs to be made by the company within 15 days after it purchases services or goods from an MSME.
• In the case of a Written Agreement, payments should be made within the period laid out in the contract. This period should not take more than 45 days after the acceptance or constructive acceptance of the goods or services.

Day of Acceptance:

The “Day of Acceptance” is the date when the payment period for goods or services begins under the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006. If there is a requirement for a quality check, the Day of Acceptance is the date that the buyer accepts upon inspection or resolution of any objection.

7. Comprehensive Examples

8. Tax Implications for Various Scenarios

9. Penalties for Delayed Payments

Interest on Delayed Payment: The rate of interest charged for delayed payment is three times the Reserve Bank of India (RBI) bank rate.

Calculation of Interest: Interest can be paid from the date stated under the agreement. Without such agreement, interest can be imposed from the date immediately following the end of the fifteenth day from the date of the buyer’s acceptance of goods or services.

Non-Deductibility of Interest: The Income-tax Act of 1961 rules that if you are paying interest to an MSME because the payment was delayed, you cannot claim the same at the time of computing the taxable income claim. This has been done to encourage payments to be made promptly to the MSMEs to prevent delays.

10. GST Component Treatment

GST as Input Tax Credit (ITC): The non-deductible component of the payment (under Section 43B (h) is merely the component other than GST. The books treat the GST component separately and adjust it as an ITC.

GST Not Claimed as ITC: In case the buyer does not claim the GST amount as an ITC, it is accounted for directly as an expense in the Profit and Loss account. The GST amount can be deducted or not based on whether the provisions under income tax Section 43B h are adhered to for the overall payment, including the GST.

GST As ITC, Case Study

• In case ₹1,20,000 is to be remitted to an MSE and this includes ₹20,000 as GST, and this GST is being used as ITC, then the law under Section 43B(h) will apply to ₹1,00,000 (the original amount) in case of delayed payment.

GST Not Claimed As ITC, Case Study 

• If ₹1,20,000 is payable to a small or medium enterprise (MSE), and the same being ₹20,000 as GST levied, and such GST is not recovered as ITC or expensed, then the entire ₹1,20,000 will be disallowed under Section 43B(h) if the same is not made in due time.

11. Capital Expenditure Implications

Limited applicability to most capital expenditure

Section 37(1) is largely concerned with whether you can deduct revenue expenses. Section 43B, however, does not ask whether an expense is revenue or capital in the context of deduction. Section 43B largely allows you to deduct specific expenses only when you pay for them, regardless of the taxpayer accounting.

Exceptions (Section 35AD, scientific research)

The full deduction for capital expenditure allowed under Section 35AD is for special business capital expenditure and investment allowance for deductions under scientific research, as covered in this section. Hence, for such specific capital expenditures subject to deduction under Sections 30 to 36, the rules in MSME section 43b h will come into effect, i.e., the deduction in the year the payment is made to the MSE.

Reference relevant court rulings.

Also, it should be noted that the provisions of Section 43B (h) should not curtail the allowance of depreciation on capital expenditure. This remark has its roots in Karnataka High Court’s rulings in PCIT v. Tally Solutions Private Limited as well as the Bangalore Income Tax Appellate Tribunal in Lemnisk Private Limited v. DCIT wherein it has been held that the provisions of Section 40(a)(i)/ Section 40(a)(ia) regarding disallowance of expense on failure to deduct withholding tax will not apply to claims of depreciation on capital expenditure.

12. Applicability to Different Tax Systems

Impact on cash system accounting users

A presumptive taxation regime permits assesses to calculate their entire income based on a stipulated formula that ignores the provisions of Sections 28 to 43C of the IT Act. Therefore, if an assessee chooses to be under the presumptive taxation regime, the provisions of MSME section 43b h will not apply to it.

Impact on cash system accounting users

In the cash system, expenditure incurred is accounted for in the profit and loss account when paid and not when payable. Accordingly, any payment made to MSEs shall be accounted for as expenditure and treated as a deduction under the IT Act when paid.

13. Registration Requirements

1. Need for Udyam Registration

To be recognized as a Micro or Small Enterprise (MSE) under income tax Section 43B (h), a business needs to register through the Udyam portal according to the MSMED Act, 2006. Without this registration, a business cannot access MSME benefits like protection from late payments and eligibility under Section 43B (h).

2. Supreme Court Ruling

The Supreme Court of India has decided that a business must have its Udyam registration during the transaction to get MSME benefits. Registering after the fact does not count as protection against delayed payments under the MSMED Act.

3. Information from MSME SAMADHAAN FAQ

The MSME SAMADHAAN portal, which helps solve payment disputes, mentions in its FAQs that only businesses registered under the MSMED Act can make complaints.

14. Benefits of Section 43b(h)

1. Benefits for Small Businesses:

• This ensures that payments arrive on time, helping small businesses manage their money more easily.
• It also encourages fair practices, stopping big buyers from taking too long to pay.
• The legal support from the MSMED Act of 2006 helps to reduce arguments about late payments.

2. Benefits for Larger Companies:

• This helps businesses plan their payments to match tax deductions, preventing unnecessary costs under income tax act Section 43b h.
• It helps businesses follow MSME rules, lowering the chances of fines or legal troubles.
• It supports a strong supply chain and builds lasting partnerships with small business suppliers.

15. How to Check MSME Registration

Steps to verify supplier registration status

Step 1: Visit the official Udyam Registration website.

Step 2: Select the ‘Print/Verify’ option and click ‘Verify Udyam Registration Number.’

Step 3: Enter your 19-digit Udyam Registration Number in the space provided. It is available on your Udyam registration certificate.

Step 4: Enter the proper verification code displayed in the Captcha image.

Step 5: Press the ‘Verify’ button to verify your Udyam registration status.

Conclusion

Section 43B (h) helps ensure that Micro and Small Enterprises (MSEs) get paid on time by connecting tax breaks to when payments are due, as stated in the MSMED Act of 2006. Businesses should:

• Keep good records of sales and payments.
• Check if suppliers are registered as MSMEs before doing business.
• Use tools to track payments and prevent delays.
• Plan payments carefully at the end of the year to take advantage of tax deductions.

By doing these things, MSEs and larger companies can follow the rules, manage their money better, and run their businesses more smoothly. For income tax filing services contact Finocircle, we have expertise in tax filing and compliance.