Section 43B (h), Friend or Foe?

Section 43B of the Income Tax Act, 1961, is an essential provision that deals with the timing of claiming certain expenses as deductions for businesses and professionals. Under this provision, individuals can claim certain payments as expenses, however, they can do so in the year it was paid and not in the year it was incurred. 

Under this section there exists various clauses. One of its recent amendments will be analysed here.

Section 43B (h): Pay MSMEs on Time or Lose Tax Benefits

This clause is a key amendment to the section, implemented to ensure timely payments to Micro, Small Enterprises & Medium Enterprises (MSMEs). Introduced in the Union Budget 2023, Section 43B(h) of the Income Tax Act aims to boost financial support for MSMEs and becomes effective from 1st April 2024 for the transaction undertaken in the financial year 2023-24.

What are Micro and Small enterprises?

Micro enterprises are those that have:

• Turnover of less than or equal to 5 crores AND

• Investment in plant and machinery is less than or equal to 1 crore

Small enterprises are those that have:

• Turnover of less than or equal to 50 crores AND

• Investment in plant and machinery is less than or equal to 10 crore

What does the provision say?

If an entity enters into a business transaction with a micro and small sized enterprise, by way of purchasing goods or availing any kind of service from them such expenses would then be allowed as deductions from the taxable profit (Section 37), hence reducing their tax liability.

This clause stands applicable to all kinds of purchases made from the enterprise which has been registered under MSMED Act, 2006. One must keep in mind that traders are NOT eligible to benefit from 43B(h).

• This clause is applicable only to Micro & Small Enterprises.

• Medium Scale Enterprises are outside the scope of this clause.

Sec 43B(h) states that any sum payable by the assessee to a micro & small enterprises beyond the time limit specified in Section 15 of Micro, Small and Medium Enterprises Development Act, 2006 shall be allowed only in computing the income referred in Section 28 of that previous year in which sum has been actually paid.

Time period for Payment:

Having understood the clause and what needs to be done by businesses to avail the benefit surrounding it, the next step is to be informed of the time limit that need to be followed.

• Section 15 of the MSME Development Act, 2006 governs the payment of goods or services to suppliers, specifically micro or small enterprises (MSEs).

• Payment must be made by the buyer to the supplier within the timeframe agreed upon in writing between them.

• The agreed-upon timeframe for payment cannot exceed 45 days from the day of acceptance of the goods or services.

• In the absence of a written agreement specifying the payment timeframe, the buyer must make the payment within 15 days from the day of acceptance.

• These provisions are crucial for businesses to comply with to avail the benefits outlined in the Act.

Result of non-payment or delayed payment:

If the sum payable is not done as per the time frame specified, the deduction would be allowed in the financial year in which it is actually paid although for current year, the amount will be added back to the profits and Tax needs to be paid on such profits.

To understand this better, let’s illustrate it with an example:

Mr. Akash has purchased goods of Rs. 10,000 from Sangam & Co, a micro enterprise on 10.3.2024. As per the written agreement between them, the payment has to be made by 10.4.2024. Mr. A follows mercantile method of accounting.

(i) If Mr. A paid the sum on 5.4.2024

Since Mr. Akash paid the sum on or before 10.4.2024, the deduction would be allowed in Income Tax Returns (ITR) of F.Y. 2023-24.

(ii) If Mr. A paid the sum on 20.4.2024

Since Mr. A paid the sum beyond the time limit, the deduction would be allowed in the year of actual payment F.Y. 2024-25

Despite the fact that this clause is very helpful to the Micro and small sector enterprise, it is threatening for businesses that has not yet paid its MSME creditors. If an enterprise does not make payment to Micro & Small Enterprises in above specified period, then it has to make payment of compound interest at monthly rests to supplier at 3 times the Bank Interest notified by Reserve Bank of India. Further, this interest expense is disallowed while computing Income under head "Profits & Gains from Business".

As more and more business are registering under MSME given its benefits, it is only going to be more tedious for businesses to track and pay off any such liability. So, make sure to check for the same in order to not bear huge additional tax liability.