Know about the new MSME 45 days payment rule - Section 43Bh

To protect the interests of Micro, Small, and Medium Enterprises (MSMEs) and ensure timely payments, Clause (h) of Section 43B, introduced by the Finance Act 2023, states that if payments to MSMEs are not completed within the specified time frame, the deduction for these amounts will only be allowed on a payment basis. This means that the deduction from the profits of the financial year will only be permissible in the year when the actual payment is made.

This change, effective from April 1, 2024, is intended to reduce working capital shortages in the MSME sector and promote timely payments to these enterprises. This change will be applicable to the assessment year 2024–2025 and subsequent years. This blog examines the implications and benefits of this new rule.

New Norms of Deduction in Payments to MSMEs Section 43B(h):

Section 43B(h) of the Finance Act states that any amount payable to a Micro & Small Enterprise that remains unpaid within the time given under Section 15 of the MSMED Act- will only be allowed as a deduction for that fiscal year in which payment is made, irrespective of any accounting system adopted. This will enable MSMEs to make timely payments by tying the actual dates of payment and the deductibility.

Applicability of Section 43B(h):

Section 43B(h) will be applicable where an enterprise acquires goods or services from a supplier registered under the MSMED Act, 2006. Notably, the registration of the buyer under the MSMED Act is not a prerequisite for the applicability of this clause.

This section incentivizes early payment to registered micro and small enterprises. This means that the advantage of Section 43B(h) will be available so long as the supplier is registered under the MSMED Act.

Benefits of Clause (h) of Section 43B for MSMEs:

Smooth Payment Cycle-

Section 43B(h) requires big businesses to pay their dues to MSMEs within the given time period: 15 days without an agreement and 45 days from the date the agreement was signed. This means that MSMEs will receive their payments on time, which is very important for their cash flow, sustainability, and growth.

More bargaining power-

With this provision in place, MSMEs can bargain for better payable terms with the larger units of operation. Knowing that delayed payments have actual costs strengthens their bargaining position.

Reduced Conflicts-

Timely payments minimise disputes and legal issues related to outstanding dues. Reduced conflict saves time and resources for both MSMEs and larger businesses, creating a more harmonious business environment.

Section 43B(h) and Its Non-Applicability to Traders:

Section 43B(h) explicitly targets timely payments to micro and small enterprises registered under the MSMED Act, 2006. Office Memorandum No. 5/2(2)/2021-E/P and G/Policy dated July 2, 2021, stipulates that wholesale and retail traders can register under Udyam only for the purpose of availing of Priority Sector Lending benefits.

Wholesale and retail traders do not fall under the MSMED Act's definition of an 'enterprise' and are not eligible for other benefits under Section 43B(h).

Example: Mr A bought goods from Mr B, who is a trader. Would Section 43B(h) apply? No, it would not because Mr. B is a trader. The provision applies only where payments are made to suppliers, who are either manufacturers or suppliers of services and not traders.

Effective Date of Section 43B(h) for MSME Payments:

Section 43B(h) is new and has been introduced under the Finance Act. Section 43B(h) will come into effect on April 1, 2024. This means this amendment will be effective for the assessment year (AY) 2024-25, which is the FY 2023-24.

Example: Mr. A bought goods from Mr. B on March 31, 2023. Does Section 43B(h) apply? No, since Section 43B(h) does not apply to those purchases made before March 31, 2023. The provision will impact only those payments made towards goods and services after April 1, 2024.

Payment Time Limits Under Section 43B(h) for MSMEs:

According to Section 43B(h), payment timelines by business enterprises to MSMEs are mandatory, as required by Section 15 of the MSMED Act, 2006. Such payment terms would depend on a written agreement between the buyer and the supplier.

If there is no written agreement, the business enterprise should pay within 15 days of buying any good or service from an MSME. However, if there is an agreement, payments should be made in accordance with the timeline stated in the agreement. However, if it is more than 45 days, payment should be made from the date of acceptance or deemed acceptance of the goods or services.

Penalties for Delayed Payments to MSMEs :

When payments to Micro, Small, and Medium Enterprises (MSMEs) are not paid in time, the buyer faces heavy punishment under the MSMED Act, 2006. Here are the details of those punishments:

Late Payment Interest-

The interest payable for the delayed payment is compounded at three times the bank rate declared by the Reserve Bank of India (RBI).

How Interest is Calculated-

Interest is payable from the date agreed upon in the contract. If no such agreement exists, interest is payable from the day following the end of the fifteen-day period from the date of acceptance or the date of deemed acceptance of the goods or services by the buyer.

Non-Deductibility of Interest-

According to the Income-tax Act of 1961, any interest paid or payable to an MSME for delayed payments is not allowed as a deduction to calculate taxable income. This rule is meant to encourage prompt payment to MSMEs and discourage delays.

Implications on GST Component if Sum Payable to MSE is Disallowed:

In determining the tax implications of the amount payable to a Micro or Small Enterprise (MSE) that includes GST, it is necessary to distinguish whether the GST amount is claimed as Input Tax Credit (ITC). Here's how the implications work out:

Situation Implication on GST Component-

GST Claimed as ITC: The non-deductible component of the payment, according to section 43B(h), relates only to the component sans the GST. GST is then treated independently and accorded ITC treatment within the books and records.

GST Not Recovered as ITC: If the buyer fails to include GST in the ITC rather than absorb it into the Profit and Loss account as an expense, the deductibility of the GST amount shall depend upon the fulfilment of conditions under Section 43B(h) by the entire amount of payment, which shall include GST.

GST as Input Tax Credit-

Condition: The enterprise claims the GST paid on purchases from an MSE as Input Tax Credit.

Implication: For income tax deductions under Section 43B(h), only the base amount, that is, the amount excluding GST, is considered. If this base payment to the MSE is delayed beyond the prescribed timelines, only this portion would be disallowed as a deduction till actually paid.

Example: If ₹1,20,000 is payable to an MSE, it includes ₹20,000 as GST. If this GST is being claimed as ITC, then the disallowance under section 43B(h) will apply to ₹1,00,000 (base amount) in case the same is not paid in time.

GST Not Being Claimed as Input Tax Credit-

Condition: The enterprise is not claiming the GST amount as ITC. The entire amount (including GST) is being recorded as an expense.

The total amount, including GST, is subject to the provisions of Section 43B(h). If the GST is not paid within time, then the total amount of such payment is disallowed as a deduction until such payments are made.

Example: If ₹1,20,000 is payable to an MSE, and ₹20,000 is included as GST, and this GST is not claimed as ITC but is allowed as an expense, then the entire ₹1,20,000 is disallowed under Section 43B(h) if not paid within the prescribed time.

Implications of Section 43B(h) on Capital Expenditure :

Of all the tax treatment provisions under the Income Tax Act regarding different expenses, the provisions of Section 43B are special because they apply to revenue as well as capital expenses under certain circumstances. Here's a more detailed look at how Section 43B(h) impacts capital expenses specifically:

Section 43B(h) Applicability Overview-

Unlike Section 37(1), which has mainly focused on the deductibility of revenue expenditures, the criteria for deduction under Section 43B are not dependent upon whether an expense is capital or revenue. The general rule of Section 43B permits the deductibility of specific types of expenditures only in the year when such payments are actually made, irrespective of any accounting method adopted by the taxpayer.

Section 43B(h)-

Section 43B deals with any sums payable that otherwise fall within the ambit of deduction under the Income Tax Act. This means if a payment to an MSE is for acquiring a capital asset, the deductions will be controlled by specific provisions that permit capital expenditure deductions.

Capital Expenditure Application-

Section 43B(h) applies to expenses paid to MSEs regarding the acquisition of capital assets, where the entire amount is allowed as a deduction under Sections 30 to 36 of the Act. This means that the payments made to MSEs for capital assets will also have to adhere to the payment conditions of Section 43B(h) in order to be allowable.

Allowable Deductions on Specific Capital Expenditures-

This also includes the complete capital expenditure under Section 35AD, wherein certain business capital expenditures have been allowed explicitly for deductions, and those related to capital investments in scientific research as allowed for deductions under the same section. So, in all these above-mentioned specific capital expenditures for which deduction is allowed under Sections 30 to 36, Section 43B(h) will be applicable, thereby ensuring that such a deduction is allowed only when payment is made to the MSE in that very year.

Conclusion

Section 43B(h) of the Finance Act 2023 helps ensure that MSEs receive payments within 45 days. Thus, it helps working capital shortages associated with MSEs, enabling them to negotiate better terms of payment and hence reducing payment disputes. Overall, it means better tax planning and creating a transparent and compliant business environment in the case of larger companies.

Additional Read:

MSME Loans for Small Businesses

Impact of digital lending on MSME in india

5 Ways to Get an MSME Loan Without Collateral