Deductions for purchases from MSE to be allowed on Payment basis| Amendment in Section 43B of Income Tax Act

For the last many years the government has provided various benefits for MSME (Micro, Small and Medium Enterprises) to boost their business. A separate portal is provided for the entities to register themselves as MSME. MSMEs are encouraged through various benefits such as collateral free loans, subsidy on patent registration, Free ISO certification etc. To take data of dues outstanding to MSME, The Companies Act also introduced Form MSME-1 wherein every company is required to disclose funds outstanding to MSME for more than 45 Days.

To encourage timely payments to MSME, The Government has made an amendment in Income Tax Act, 1961. Section 43B of the Income Tax Act provides for certain expenses for which deduction is allowed on payment basis, i.e., deduction is allowed during the year in which payment is made for such an expense. A new clause (h) has been added to Section 43B related to payments to MSME.

This article contains a detailed discussion of Section 43B(h) of Income Tax Act.

1. Amendment in Section 43B of Income Tax

Following new Clause (h) has been inserted to Section 43B of Income Tax Act:

“43B Certain deductions to be only on actual payment.

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

….

(h) 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 (27 of 2006),

shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him:

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 such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return

…

Explanation 4.—For the purposes of this section,—

…

(e) “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);

….

(g) “small enterprise” 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).”

2. Interpretation of provisions of Section 43B(h)

As per Section 43B(h), every assessee is required to make payment to the micro and small enterprises (MSE) within the time limit specified.
If any sum is payable to the MSE at the end of the financial year beyond the specified time limit then deduction for such amount shall be allowed during the financial year in which such sum is actually paid.
As per proviso to Section 43B, for payments given under 43B(a) to 43B(g), deduction shall be allowed during the year in which such expense is incurred if payment is made upto the due date of filing of Income Tax return under Section 139(1) of Income Tax Act for such year.
However, such proviso is not applicable to clause (h) of Section 43B.
Therefore, if the amount payable to the MSE, outstanding beyond specified time limit, is paid after the end of the Financial year then deduction for such expense shall be allowed during the financial year in which payment is made.
It is pertinent to note that Clause (h) includes only Micro and Small Enterprises. Medium enterprises are not covered under this clause.

3. What is the meaning of Micro and Small Enterprises

3.1 Classification of Entities as Mirco, Small or Medium Enterprises

As per Explanation 4 to Section 43B:

“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); and
“small enterprise” 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).

As per Notification No. F. No. 2/1(5)/2019-P&G/Policy (Pt.-IV) dated 1st July, 2020, following is the classification of enterprises:

Classification	Investment in Plant & Machinery or Equipment	Turnover
Micro Enterprises	Does not exceed INR 1 Crores	Does not exceeds INR 5 Crores
Small Enterprises	Does not exceeds INR 10 Crores	Does not exceeds INR 50 Crores
Medium Enterprises	Does not exceeds INR 50 Crores	Does not exceeds INR 250 Crores

For the classification of any entity as Micro, Small or Medium, both the criterias are required to be satisfied simultaneously.

3.2 Whether traders are covered under MSME Act

Reference is required to be given to the definition of “Enterprises” given under Section 2(e) of MSME Act.
As per Section 2(e) of MSME Act, “enterprise” means an industrial undertaking or a 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;
As per MSME Act, entities engaged in manufacturing or production of goods or provision of services are covered under MSME. Therefore, trader entities are not covered under the definition of MSME enterprises.
However, one may have doubt that UDYAM Portal (site used for MSME registration) allows registration of traders as MSME.
For this purpose, one is required to refer to Office Memorandum No. 5/2(2)/2021-E/P&G/POLICY dated 02.07.2021.
As per clause No. 2 of Office Memorandum, TheGovernment received various representations and it has been decided to include Retail and wholesale trades as MSMEs and they are allowed to be registered on Udyam Registration Portal. However,benefits to Retail and Wholesale trade MSMEs are to be restricted to Priority Sector Lending only.
Therefore, wholesale and retail traders are allowed to register on MSME portal only for Priority sector lending purpose.
Further, vide Officer Memorandum No. 1/4(1)2021-P&G/Policy dated 01.09.2021, the Government has clarified that the benefits to Retail and Wholesale trade MSMEs are restricted upto Priority Sector Lending only, and any other benefits, including provisions of delayed payments as per MSMEDAct, 2006, are excluded.
For MSME benefits, other than primary sector lending, traders are not covered under MSME. However, for the purpose of Section 43B(h) of Income Tax Act, MSME Can get covered under the definition of Micro, Small and Medium Enterprises.
Therefore, unless any other clarification is issued by the Income Tax Department, it is suggested to include traders under Section 43B(h).

3.3 Whether it is mandatory to register under MSME Act to get covered under MSME

Any entity which qualifies the criteria given for MSME may still opt not to register under MSME Act on UDYAM Portal.
However, once an entity qualify the status of MSME under MSME Act, it shall hold the status of MSME irrespective of its registration on Udyam Portal.
Therefore, a supplier may fall under Clause 43B(h) even if it is not registered under MSME Act.

4. What is the time limit for payments to MSE Enterprises for Clause 43B(h)

As per Clause 43B(h) of Income Tax Act, any sum payable at the end of year to the Micro or small enterprises beyond the time limit specified under Section 15 of MSME Act shall be considered for addition.

Time Limit as per MSME Act:

Criteria	Due date for payment
Period is agreed upon between buyer and seller	the buyer shall make payment on or before the date agreed upon. (Agreed period shall not exceed 45 days from the day of acceptance in any case)
No period agreed upon between buyer and seller	The payment is required to be made within 15 days from date of acceptance or the day of deemed acceptance of supply

“the day of acceptance” means,
- the day of actual delivery of goods or the rendering of services; or
- In case of any objection is marked by the buyer, the day on which such objection is removed;

“the day of deemed acceptance” means, where no objection is made by the buyer regarding acceptance of goods or services within 15 days from the day of the delivery of goods or the rendering of services, the day of the actual delivery of goods or the rendering of services;

Due dates of payment and year of deduction under Section 43B(h) of Income tax Act, can be understood with following examples:

Date of Supply of Goods or provision of Services	Scenario	Due date of Payment	Actual Date of Payment	Year of Deduction(Financial Year)
01.03.2024	No date is agreed upon between buyer and seller	16.03.2024	25.03.2024	2023-24
01.03.2024	No date is agreed upon between buyer and seller	16.03.2024	16.04.2024	2024-25
01.03.2024	Period of 30 days agreed between buyer and seller	31.03.2024	16.04.2024	2024-25
01.03.2024	Period of 45 days agreed between buyer and seller	15.04.2024	14.04.2024	2023-24
01.03.2024	Period of 45 days agreed between buyer and seller	15.04.2024	25.04.2024	2023-24

5. Applicability of provision of Section 43B(h)

Clause (h) has been inserted under Section 43B through Finance Act, 2023 applicable with effect from 01.04.2024. Therefore, same is applicable with effect from AY 2024-25

6. Treatment of Balance outstanding as on 01.04.2023 to MSE

As per Section 43B(h) of Income Tax Act, a deduction otherwise allowable during the year shall be allowed during the year in which payment is made to Micro and small enterprises. Therefore, amount which is otherwise not deductible during the year is not covered under Section 43B(h).

Amount outstanding at the beginning of financial year, i.e., 01.04.2023, is not claimed as deduction during FY 2023-24 as deduction for the same is claimed in the year such purchase is recorded. Therefore, provisions of Section 43B(h) is not applicable to balance outstanding as on 01.04.2023 to the MSE.

7. Conclusion

The Amendment 43B is surely a powerful move to ensure timely payment to MSE. Industry will ensure timely payments to MSE to avoid any disallowances. These implications will create a healthy environment for Small & MIcro enterprises However, this clause contains a lot of ambiguity and a detailed clarification is required to be issued by the Income Tax Department to avoid litigations.