Demystifying Section 43B(h): A Deep Dive into Micro and Small Enterprises Payment Compliance

Background of this clause

The recent amendment introduced by the Union government in Section 43B(h) of the Income Tax Act is a significant social-economic measure aimed at bolstering the MSME sector. Despite the explicit prohibition of any delay beyond 45 days in the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act, 2006), adherence to this regulation has been more observed in breach than in practice. The report released on May 12, 2022, by the Global Alliance for Mass Entrepreneurship (GAME) and Dun & Bradstreet (D&B) reveals that estimated delayed payments across all MSMEs amount to about Rs 10 lakh crores. The annual interest cost alone on this staggering amount is Rs 1 lakh crore. If the delayed payments are cleared as per the provision of the 2006 Act it would be like releasing a subsidy of Rs 1 lakh crore to the MSMEs. This will help in the credit revolution for Micro and Small enterprises.

Section 43B(h) of Income Tax Act, 1961

The Finance Act of 2023 has introduced an amendment under Section 43B, by inserting clause (h), which reads as follows: \"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.\"

A crucial addition to this amendment is found in the proviso to the section, which states, \"Provided that nothing contained in this section except the provisions of Clause (h) shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of Income under Sub-section (1) of section 139 in respect of the previous year in which the liability to pay the sum was incurred as aforesaid, and evidence of such payment is furnished by the assessee with such return.\"

The amendment to section 43B of the Income Tax Act, 1961 Act, as interpreted, allows the deduction of payments to MSEs exclusively on a payment basis. Accrual basis deduction is permissible only if payment aligns with the timeframes mandated under section 15 of the MSMED Act.

What is Micro and Small Enterprise?

As per explanation 4 of section 43B, clause (e) states that micro enterprise shall have the meaning assigned to it in clause (h) of section 2 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006). Clause (g) of the same explanation states that small Enterprises shall have the meaning assigned to it in clause (m) of section 2 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006).

Now Union Ministry of Micro, Small, and Medium Enterprises has issued a Gazette Notification to pave the way for the implementation of upward revision in the definition and criteria of MSMEs in the Country. A revision in the MSME definition was announced in Aatmanirbhar Bharat Package on 13th May, 2020. As per this announcement, Micro Enterprises means an enterprise having Rs. 1 crore investment in Plant & Machinery (P&M) or equipment and Rs. 5 crore turnover. Small enterprises means an enterprise having Rs. 10 crore investment in P&M or equipment and Rs. 50 crore turnover.

REVISED MSME CLASSIFICATIONS - Composite Criterion: Investment in Plant & Machinery/Equipment and Annual Turnover

Turnover and investment limits are the only eligibility criteria for registration as an MSME. All organizations falling within the turnover and investment limits that want to be classified as MSMEs are required to register on the Udyam registration portal. The official website for registration is udyamregistration.gov.in. Upon registration, an \"Enterprise Registration Number\" will be allotted to the enterprise and an e-certificate of registration will also be issued.

Decoding Payment Timelines under section 15 of MSMED Act, 2006

Section 15 of the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 lays down explicit guidelines for payment timelines between buyers and suppliers of goods or services.

The section stipulates that where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing or, where there is no agreement on this behalf, before the appointed day:

Provided that in no case is the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance.

The term \"appointed day\" is defined as the day immediately following the expiry of the fifteen-day period from the day of acceptance or the day of deemed acceptance of goods or services by the buyer from the supplier. For clarity, the day of acceptance is determined either by the actual delivery of goods or services or, in case of written objection by the buyer within fifteen days from delivery, the day when such objection is resolved by the supplier. In situations, where no written objection is raised by the buyer within fifteen days from the delivery of goods or services, the day of deemed acceptance aligns with the actual delivery.

To sum up, Section 15 of the MSMED Act establishes a framework for timely payments to MSEs, emphasizing the importance of written agreements and setting a maximum limit of 45 days for payment realization. In the absence of a written agreement, the default timeline for payment is mandated to be within 15 days, safeguarding the interests of Micro and Small Enterprises in their business transactions.

Tax Audit Report

In accordance with Notification No. 27/2024-Income Tax dated March 5, 2024, a notable amendment has been introduced to clause 26 of Form 3CD. The new clause 26 of Form 3CD can be read as \"In respect of any sum referred to in clauses (a), (b), (c), (d), (e), (f), (g) or (h) of section 43B, the liability for which:-

1) Pre-existed on the first day of the previous year but was not allowed in the assessment of any preceding previous year and was

(a) paid during the previous year;

(b) not paid during the previous year;

II) Was incurred during the previous year and was

(a) paid on or before the due date for furnishing the return of income of the previous year under section 139(1);

(b) not paid on or before the aforesaid date.\"

In light of these developments, the onus now falls on the tax auditor to meticulously examine the accounts of MSME creditors. The primary objective is to scrutinize and report on disallowances under section 43B(h), with the findings to be documented in the revised Form 3CD. This procedural refinement enhances the rigour of the tax auditing process, ensuring thorough compliance and transparency in adherence to regulatory frameworks.

Compliance framework and reporting requirement relating to MSMEs under other laws:

I. Impact of Section 23 of MSMED Act on Income Tax Act, 1961

Section 23 of the Micro, Small, and Medium Enterprises Development (MSMED) Act explicitly states that interest payable or paid by any buyer under the provisions of this Act shall not be allowed as a deduction for the computation of income under the Income-tax Act, 1961. This provision, with its overriding effect, emphasizes the significance of aligning with the MSMED Act\'s stipulations regarding interest deductions.

II. Companies Act Disclosure Mandate

The Companies Act necessitates distinct disclosure of outstanding balances and related interest due to MSMEs in financial statements. The Ministry of Corporate Affairs, through its notification issued on the 24th of March, 2021 (G.S.R. 207(E)), guides that companies must present a detailed breakdown of trade payables, categorizing outstanding amounts for different periods from the due date of payment. This disclosure framework enhances transparency and compliance with the Companies Act.

As per MCA notification, Trade payables should be reported as per below format:

III. GST Provisions on Timely Payments

GST provisions mandate that payments to vendors, whether MSEs or not, must be made within 180 days. Failure to meet this timeline requires the reversal of input tax credit along with applicable interest. This statutory requirement underscores the importance of prompt payment practices in accordance with GST regulations.

IV. Reporting Requirements under Section 22 of MSMED Act, 2006

Section 22 of the MSMED Act, 2006 mandates reporting requirements in the annual statement of accounts. Buyers are subject to annual audit obligations and must furnish additional information, including the principal amount and interest due, unpaid amounts to suppliers at the end of each accounting year, interest payments made, and accrued interest.

RBI Circular on MSME payments

The Reserve Bank of India, through circular No. IECD.No.20/08.12.01/2002-03, has laid down crucial mandates regarding payments to Micro and Small Enterprises (MSEs). According to the circular, to take care of the payment obligations of large corporate borrowers to MSEs, banks have been advised that while sanctioning/renewing credit limits to their large corporate borrowers (i.e. borrowers enjoying working capital limits of Rs. 10 crores and above from the banking system), to fix separate sub-limits, within the overall limits, specifically for meeting payment obligations in respect of purchases from MSEs either on the cash basis or on bill basis. Banks are also advised by RBI to closely monitor the operations in the sub-limits, particularly with reference to their corporate borrowers\' dues to MSE units by ascertaining periodically from their corporate borrowers, the extent of their dues to MSE suppliers and ensuring that the corporate pay-off such dues before the \'appointed day\' /agreed date by using the balance available in the sub-limit so created.

Navigating Practical Implications of Section 43B(h)

1. What if MSEs fall under the limit of section 7 of the MSMED Act, 2006 but do not have a Udyam registration?
   The clarity surrounding the requirement of Udyam registration in the context of Section 43B(h) remains elusive, with no explicit clarification from the Government or the Central Board of Direct Taxes (CBDT). To shed light on this matter, we turn to the Micro, Small, and Medium Enterprises Development (MSMED) Act of 2006.
   The MSMED Act, under section 2(n), defines a supplier as a micro or small enterprise that has filed a memorandum with the authority specified in sub-section (1) of section 8. Section 8, in turn, grants the discretion to any person intending to establish a micro or small enterprise to file the memorandum with the relevant authority as specified by the government. While the legislation suggests that a micro or small enterprise may exercise discretion in applying for registration, the government has mandated this registration for all Micro and Small enterprises.
   From a practical standpoint, Section 43B(h) appears to apply to all micro and small enterprises, regardless of their registration status. If lawmakers would have made MSME registration mandatory for 43B(h) then large entities may prefer to get goods/ services from unregistered suppliers and this will defeat the purpose of this law.
2. Impact of Presumptive Taxation on Section 43B(h) Disallowance
   When a buyer chooses the Presumptive Taxation Scheme under sections 44AD and 44ADA, it introduces a significant implication for the application of Section 43B(h) in the Income Tax Act. Section 44AD commences with the phrase \"Notwithstanding anything to the contrary contained in sections 28 to 43C,\" while Section 44ADA begins with \"Notwithstanding anything contained in sections 28 to 43C.\" Both these sections explicitly override the disallowance provisions of Section 43B(h). Consequently, based on the author\'s understanding and considering the absence of specific clarification by the CBDT, if an assessee, the buyer in this context, opts for presumptive taxation under either Section 44AD or Section 44ADA, it is interpreted that Section 43B(h) does not apply to the assesses. However, it is suggested that one should take into consideration any decision on this issue before forming a view.
3. Capital Purchases from MSEs
   Disallowance is not applicable for the amount payable in respect of the purchase of assets, as a deduction is not claimed of such an amount.
4. Partial payment to MSEs
   A plain reading of the provisions suggests that in case of partial payment, the proportionate amount will be disallowed under the said section. For example, Purchases are made from Micro/Small enterprises on July 1, 2023. Price of goods Rs. 20 lakh, GST Rs. 3.60 lakh and total dues Rs. 23.60 lakh. Payment of Rs. 10 lakhs was made on 30 Jan, 2024. Then the disallowed amount as per section 43B(h) will be Rs. 11,52,542 (Amount eligible for deduction x remaining payable/ total purchases including GST i.e. 20 x 13.60/23.60).
5. Payable to MSEs converted into Loan/Debenture
   Purchases are made from Micro/Small enterprises on Dec 1, 2023. The price of goods is Rs. 80 lakhs. On February 1, 2024, dues are converted into loans of Rs. 80 lakh carrying interest of 6% p.a. In this case, payment is made beyond MSMED Act due date, therefore, Sec. 43B is applicable. However, liability is discharged before the close of the previous year. Therefore, eligible for deduction for the A. Y. 2024-25. This can be concluded from the Supreme Court judgment. In M.M. Aqua Technologies Pvt Ltd. v. Commissioner of Income Tax [CIVIL APPEAL NOS.4742-4743 OF 2021 dt. 21 August 2021], the issue was the discharge of interest liability through the issue of debentures. The Supreme Court held that the discharge of interest payable to financial institutions by way of issue of debentures allows actual payment of interest and is allowed as a deduction under Section 43B. The Court reasoned that the interest was actually paid by the issuance.
6. Creditor\'s Balances as on 31.03.2023
   Since this amendment will take effect from 1st April 2024 and will accordingly apply to the assessment year 2024-25 and subsequent assessment years. The creditor\'s balance outstanding as of 31st March, 23 is already been claimed as a deduction in earlier year. Hence, this clause is not applicable in such balances. A view can be that this gives rise to one tax saving strategy, the buyer can claim a deduction for current year purchases by allocating payment made during the year with current year invoices first.
7. Purchases from Traders/Wholesalers / Retailers / Distributors
   This clause applicable to payment to MSEs covered in section 7 of MSMED Act, 2006. Section 7 MSMED Act, 2006 read with section 2(e) of the same act specifies that an industrial undertaking or business concern or any other establishment, by whatever name called, engaged in the manufacture or production of goods, in any manner, pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951 (55 of 1951) or engaged in providing or rendering of any service or services.
   In the Office Memorandum No. 5/2(2)/2021-E/P & G/Policy dated 02/07/2021, issued by the Ministry of Micro, Small & Medium Enterprises, Government of India, the following decision has been communicated.
   \"The Government, in response to numerous representations received, has decided to incorporate Retail and Wholesale trades within the ambit of Micro, Small, and Medium Enterprises (MSMEs).\"
   Consequently, these entities are now eligible for registration on the Udyam Registration Portal. However, it is important to note that the benefits extended to Retail and Wholesale trade MSMEs will be confined to Priority Sector Lending exclusively.
   Also, later in the same year Ministry of Micro, Small & Medium Enterprises vide Office Memorandum No. 1/4(1)/2021 P&G Policy E-19630 dated 01/09/2021 clarifies that Retail and Wholesale Trade MSMEs are exclusively entitled to benefits related to Priority Sector Lending, and any other advantages, including provisions for delayed payments under the MSMED Act, 2006, remain excluded for these specific sectors.
   Taking into account the aforementioned provisions and the issued office memorandums by the Ministry, a view can be taken that the transactions with traders, retailers, or distributors are outside the scope of Section 43B(h), providing relief from the disallowance provisions outlined in the section.
8. Further Action on Outstanding payments
   Buyers engaging with Micro and Small Enterprises (MSEs) should begin by verifying the MSE status of suppliers. If the buyer does not have any written agreement, then get the written agreement on paper or in the mail from the supplier specifying the payment terms of 45 days or a shorter period, as may be agreed by them. For the supplier who has provided the agreement as mentioned above buyer should check the aging report and get the payment completed within 45 days or if any shorter than the period specified in the agreement, then within such period, to get the deduction of such payment in the same financial year. If the supplier does not provide any agreement, then the buyer should pay such supplier within 15 days to get the deduction of purchases of goods or services in the same financial year.

Conclusion

The recent amendment to Section 43B(h) marks a pivotal stride in addressing persistent challenges associated with delayed payments to Micro and Small Enterprises (MSEs). While it brings forth challenges for industries such as cashflow concerns and collating information from suppliers, its overall impact is anticipated to be highly positive for MSEs, fostering improved cashflows. The confluence of income tax laws with the MSMED Act underscores the importance of meticulous compliance and reporting by taxpayers and auditors. This provision beneficial to MSMEs should not be implemented in such a way as to discourage enterprises from transacting with the MSMEs. This article serves as a comprehensive guide, aiding in navigating the intricacies of this legislative change and its practical implications on businesses and tax compliance.