One of the most talked about parts of the recent Union Budget 2023 was the unprecedented inclusion of payments to Micro and Small Enterprises (MSE) vendors within the ambit of Section 43B of the Income Tax Act 1961. Section 43B contains provisions pertaining to “Income from Business and Profession.” It lists all the expenses a given business entity can seek as deductions from their business income only in the financial year when they make the actual payment, disregarding the year when the entity incurred such expenses. Thus, it advocates deduction of spending on an actual payment basis.
The inclusion of payments to MSE vendors in the above regulatory framework strives to address the key issues MSEs counter as a result of prolonged payments. MSEs make up a fundamental segment of the Indian business ecosystem. According to quantitative analysis estimates by the Economic Times, delayed payments to MSMEs in India have resulted in approximately Rs 10.7 lakh crore being held up, which represents around 6% of India’s Gross Value Added (GVA) for the financial year 2020-21.
The addition of the MSE payments clause (h) in Section 43B can prove as a cornerstone amendment to streamline the payment receipt process for MSE ventures. Business organizations dealing with MSE suppliers, need to duly comprehend the applicability of the amended Section 43B on your payments. You also need to pay attention to the requirements of Section 15 of the Micro, Small, and Medium Enterprises Development Act (MSMED), 2006. The latest Finance Bill 2023 permits the deduction of expense paid to MSEs in line with Section 43B only when it abides by the time limit specified in Section 15 of the MSMED Act 2006. Thus, one can claim deduction on payment to MSE vendors if they are paid within 15 days in cases where there is no agreement, or 45 days or as per the time period in a pre-defined written agreement, whichever comes first.
We have some practical insights explaining the appropriate treatment of payments made to MSE vendors in different circumstances where we have assumed that there is predefined written agreement. Let us take a look at some practical situations that outline whether you are eligible to claim deduction for MSE vendor payments as per the new clause addition.
Illustration 1: A made a payment to a MSE after the time limit set by section 15 of the MSMED Act, 2006, but within the same financial year in which the expense was incurred.
In this situation, A settled the payment after the specified time limit of Section 15 of MSMED Act, 2006. This activates the revised provisions of Section 43B. However, as the payment was made within the same financial year that the expense was accrued, deduction shall be permitted in that financial year as outlined by the regulations of the Income Tax Act, 1961.
Illustration 2: B completes payment to a MSE within the time limit specified under section 15 of the MSME Act, 2006 and during the same financial year that the expense is accrued.
The provisions of section 43B of the Act would not apply to the payment that B made to the MSE. He will be permitted to get a deduction in the financial year in which the expense was accrued.
Illustration 3: C dealt with an MSE where he had expenses that accrued in March 2024, but he paid the vendor during the subsequent financial year in April 2024, within the deadline specified under section 15 of the MSMED Act, 2006.
In this situation, C made the payment as per the time limit specified under section 15 of the MSMED Act, 2006. Thus, the payment will be permitted in C’s tax calculation on an accrual basis in the financial year 2023-2024.
Illustration 4: D had an expense payable to an MSE that accrued in the financial year 2023-2024 but he settled it in the subsequent financial year 2024-25 after the time limit prescribed under section 15 of the MSMED Act, 2006 ended.
In this scenario, as the payment is made beyond the time limit as prescribed under section 15 of the MSMED Act 2006 and also in the subsequent year 2024-25, D will not be eligible for deduction of the said payment in the financial year 2023-2024 when the expenses accrued.
Illustration 5: E Dealt with an MSE where he received invoice dated 16 March 2024 with respect to supply of goods delivered on the same day. E having an issue with regards to the quality of goods supplied, communicated the same to MSE vendor on 18 March 2024. Both the parties reached a conclusion with regards to the dispute on 30 April 2024 and accordingly E made a payment on 31 May 2024.
In this scenario, as dispute with regards to the invoice was communicated within 15 days of the date of delivery therefore time limit under section 15 of the MSMED Act 2006 is applicable from the date on which dispute is resolved. And accordingly as the payment is made within 45 days from the date on which dispute was resolved, E will be eligible for deduction of the said payment in the financial year 2023-24 when the expenses accrued.
Thus, we saw that it is critical to adhere to the relevant regulatory requirements specified in both the Income Tax Act 1961 and the MSMED Act 2006 to claim timely deductions and optimise your tax liability. If you are unsure about the MSME registration status of your vendor, you can suffer with disallowed payment deduction and late payment penalties.
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