Question 1: What is the amendment inserted in the Finance Act 2023?
Finance Minister Nirmala Sitharaman, while announcing the Budget for the financial year 2023-24, proposed a measure to support Micro and Small Enterprises (MSEs) in receiving timely payments. The proposal involves allowing deductions for expenditures incurred on payments to MSEs only when the payment is actually made. This proposal was passed vide the Finance Act 2023.
The legislative amendment, effective from the Assessment Year 2024-25 starting April 1, 2024, aims to address delayed payments to MSEs. Payments made to such enterprises have been included within the ambit of Section 43B Income-tax Act, 1961 (herein after “the Act”). A new clause (h) has been inserted in Section 43B of the Act to provide that any sum payable by the buyer to MSEs beyond the time limit (as mentioned below) specified under Section 15 of the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 shall be allowed a deduction under the Act only on actual payment.
Question 2: Who are categorised as Micro or Small Enterprises under MSMED Act?
In India, the Ministry of Micro, Small & Medium Enterprises (MSME) classifies Micro and Small enterprises based on investment in plant and machinery or equipment, and annual turnover.
For micro-enterprises - the investment in plant and machinery[1] should not exceed Rs.1 crore, and the annual turnover should not be more than INR 5 crore.
For small enterprises, the investment in plant and machinery or equipment should not exceed Rs.10 crore, and the annual turnover should not be more than INR 50 crore.
Question 3: Whether Section 43B(h) of the Act applies to payments made to a trader?
Section 43B(h) of the Act applies to the supplier categorised as a manufacturer and/or service provider registered as a MSEs under the MSMED Act. In light of the above, any transactions with the traders[2] may ought to be outside the purview of the Act.
Question 4: What is the timeline for the buyer to make the payment to MSEs as per the new amendment?
As per Section 15 of the MSMED Act, payments should be made to MSEs as follows:
In the case of a written agreement – Payments should be made within 45 days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier or the time specified in the written agreement, whichever is earlier.
In case of no written agreement - Payments must be made within 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.
Question 5: What are the implications in case of non-payment to the MSEs as per the above-mentioned timelines?
Payment of interest: As per the Section 16 of the MSMED Act, the recipient / buyer shall be liable to pay compound interest with monthly rests to the supplier on the amount from the date agreed upon (i.e. due date), at three times the bank rate notified by Reserve Bank of India.
Disallowance of principal amount under the Act: As per Section 43B(h) of the Act, the principal amount / amount payable to the MSEs shall be disallowed in the computation of income, and a deduction shall be subsequently allowed only after actual payment has been made.
Disallowance of interest amount under the Act: Section 23 of the MSMED Act has specifically prohibited the taxpayer from claiming the deduction from the income on account of interest paid to MSME. In light of the above, as payment of interest is considered penal in nature, no deduction will be allowed under Section 37 of the Act.
Reporting in the tax audit report (Form 3CD): The tax auditor shall be required to report the following in Form 3CD of the tax audit report:
Unpaid dues to 'micro' and 'small' enterprises; and
Interest payments are made to 'micro' and 'small' enterprises under Section 23 of the MSMED Act.
Under the Companies Act, 2013, a company is required to file form MSME-1 (a half-yearly return) in order to capture the outstanding dues when payments are due to MSME for more than 45 days from the date of acceptance of the services or goods, along with the reason for its delay.
Question 6: Interplay between Section 40(a)(ia) and 43B(h) of the Act.
If the tax (on applicable payment) is not deducted by the assessee and payment isn't made to the micro and small enterprise within the stipulated timeframe mentioned above, the disallowance occurs under the Section 43B(h) rather than the Section 40(a)(ia) of the Act.
Question 7: Whether the said amendment apply to the taxpayers opting for presumptive tax schemes under the Act?
There is no disallowance under Section 43B(h) of the Act as Sections 44AD, Section 44ADA and Section 44AE of the Act take precedence over Sections 28 to 43C of the Act. In light of the above, this provision does not apply to businesses filing returns (under the presumptive tax schemes).
Question 8: Applicability of Section 43B(h) of the Act in case tax audit is not applicable?
Provision of Section 43B(h) of the Act shall apply even in case of non-applicability of the tax audit.
Question 9: If the service receiver is registered as an MSME, whether the section still applies to them?
The said amendment will apply to all the MSEs that procure goods/services from other MSEs.
Question 10: In the case of capital expenditure whether depreciation shall be allowed on the purchase of fixed assets if the payment is not done within the due date to the MSEs?
Provisions of Section 43B(h) of the Act apply to 'any sum payable' i.e. covering revenue expenditure along with capital expenditure. In case of where the expenditure is being capitalised, depreciation on the same shall not be allowed if the recipient has failed to make the payment to the MSEs within due date.
Question 11: Whether part payment shall qualify for a deduction on a payment basis?
Since the mandate of Section 43B(h) of the Act provides for deduction on an actual payment basis, hence, even if a 'micro' and/or 'small' enterprise has been paid in part, then deduction to the extent of such part payment shall be allowed.
Question 12: Whether unpaid GST component pertaining to an invoice issued by the MSEs qualify as a disallowance for the purpose of Section 43B(h) of the Act?
In case where the taxpayer does not claim an input tax credit under GST and treats the same as an expenditure in the profit and loss account then deduction of the unclaimed GST component shall be allowed only on an actual payment basis.
Question 13: What is the effective checklist in order to be compliant with the laws?
Collect MSE certificates from all vendors and prepare a list of vendors with MSE certificates;
Check the registration number / MSME Udyog number on all MSE invoices and its status as a 'micro' / 'small' enterprise, as may be applicable;
Execute agreements or issue purchase orders mentioning terms of payment; and
Ensure timely payment as per the above guidelines.
This article has been co-authored by Wilren Rebello (Associate, Transaction Advisory-Finance & Tax), Akshay Sai (Senior Associate, Transaction Advisory-Finance & Tax), and Harshal Mehta (Manager, Transaction Advisory-Finance & Tax).
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[1] Notification No. S.O. 2119(E) dated June 26, 2020, read with RBI/2020-2021/26 - FIDD.MSME & NFS.BC.No.4/06.02.31/2020-21 dated August 21, 2020
[2] O.M. 5/2(2)/2021-E/P & G/Policy dated July 02, 2021, read with office memorandum dated September 01, 2021