How is the Income Tax Act regulating business practices to ensure

How is the Income Tax Act regulating business practices to ensure timely Payments to MSME? 

MSME are growth engines & vital catalysts for our economy. The Micro, Small and Medium Enterprises Development Act (MSMED) was enacted to nurture MSME in the country. As per section 15 of the MSMED Act, payment to Micro and Small enterprises has to be done before the Appointed Day. The Appointed Day is 15 days from the date of actual delivery of goods or the rendering of services. While the MSMED Act already enforces timely payments, its implications now extend to the Income Tax Act-1961.

At present, Section 43B of the Income Tax Act provides for deduction of certain expenditure only on actual payment basis i.e., the deduction is available only if the amount is paid within the prescribed time period. If the payment is not done then the deduction is either not available or it is available in the year of the payment. Few of the existing transactions which are covered by section 43B include taxes/duties/cess, interest payable to Banks/NBFC, Payment towards PF/ESIC, etc. Finance Act – 2023 has widened the scope of section 43B so as to include the payments to micro and small enterprises also in accordance with the provisions of MSMED Act. As a result, deduction for purchase of any goods/services or towards expenses availed from Micro and Small Enterprises shall be allowed only if the payment is actually made within the period agreed between the buyer & seller. If the period agreed in writing is beyond 45 days then the payment has to be done within 45 days only. If there is no agreement then the payment has to be done before the appointed date (i.e., 15 days).

Unlike other items of section 43B like taxes/duties/cess, etc wherein the deduction is available if the payment is done on or before the due date of filing the Income Tax Return (ITR), the payment to Micro & Small enterprises shall not be admissible as deduction if the same is paid after the end of the financial year and the period of 15 days or 45 days is over. Deduction is admissible only if the payment is either done in the same financial year or within a period of 15 days or 45 days if the same is falling due after 31^st March.
Let us understand the impact of the above provision with the following example wherein purchase is done without any written agreement and there is no stipulation to make the payment before 15 days. As a result the payment is required to be do done within 15 days of delivery of goods:

In the first case, even though the payment is done after the appointed date under MSMED Act, still it is done within the same financial year (FY) and so it will be eligible for deduction in the FY 2023-24.

In the second case, the appointed date of payment was 30.03.24 (i.e., FY 2023-24). Since the payment was not done by 31.03.24 but paid in next FY, deduction would be admissible in the FY 2024-25.

In the third case, the appointed date was falling in the FY 2024-25 and since the payment was done before that, deduction would be admissible in the FY 2023-24.

In the fourth case, the purchase was done in the FY 2023-24 but the payment was not done before the appointed day. As a result deduction would not be admissible in the FY 2023-24 but would be admissible in the FY 2024-25 in which the payment is done.

The above illustration is covering the case where no written agreement exists and so the appointed day is 15 days. The same logic & working can be applied if there exists a written agreement wherein the payment would be required to be done before the dates as per mutual agreement (& if the mutually agreed period exceeds 45 days, the payment would be required to be done within 45 days).

Applicability to Traders:
This is the most important issue raised by many. Section 43B(h) is applicable only in respect of the amount payable to Micro or Small Enterprises. Pure Traders (even if Registered under the MSMED Act 2006 or have obtained Udyam registration) are not covered in the definition of Micro or Small Enterprises. So, there will be no disallowance u/s 43B(h) if payment to such traders is done even beyond 45 days. One may also refer to the Office Memorandum Dated 01.09.2021 issued by the Ministry of MSME which clarifies that the registration is restricted for priority sector lending only.

  Invoice can be considered as Written Agreement?:

Written agreement is must for the benefit of 45 days U/s 43B(h). In my opinion, if the invoice/purchase order/delivery memo etc mentioned the period of 45 days or more, it would be sufficient to draw inference that there exists a written agreement.

Non Payment due to disputes:
The period of 15 days or 45 days is applicable from the date of acceptance or deemed acceptance. “The day of acceptance” means
(a) the day of the actual delivery of goods or the rendering of services; or
(b) where any objection is made in writing 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 on which such objection is removed by the supplier;
and “The day of deemed acceptance” means, where no objection is made in writing by the buyer regarding acceptance of goods or services within fifteen 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;

If the buyer has made a written objection, the date of acceptance shall be reckoned from the date of resolution of the disputes.

Ensuring Compliance with new provision for the FY 2023-24:

1. In respect of Purchase / Services without written agreement:
   Ensure that payment is done before 31^stMarch 2024 against all purchases/services done from 1^st April 2023 to 16^th March 2024. In short, all creditors as on 16^th March 2024 (excluding opening creditors as on 01.04.2023) towards purchases/services are to be paid off till 31^st March 2024.
   In respect of purchases done from 17^th March to 31^st March 2024, the payment shall be required to be made within 15^th day of its purchase failing which the deduction would not be available in the FY 2023-24.
2. In respect of Purchase / Services with written agreement of more than 45 days:
   In such a case, the buyer needs to ensure that the payment is done before 31^stMarch 2024 against all purchases/services done from 1^st April 2023 to 15^th Feb 2024. In short, all creditors as on 15^th Feb 2024 (excluding opening creditors as on 01.04.2023) towards purchases/services are to be paid off till 31^st March 2024.
   In respect of purchases done from 16^th Feb to 31^st March 2024, the payment shall be required to be made within 45^th day of its purchase failing which the deduction would not be available in the FY 2023-24.

Conclusion:

1. Every new law comes with a new set of complications and confusions. Section 43B(h) will have many as it will affect each and every business house. Understanding and adhering to the provisions of section 43B(h) is crucial to avoid significant tax liabilities. Though the mutual terms and conditions of payment may be different, yet the provision of MSMED Act & Income Tax Act will prevail over it.
2. While the intention behind this provision is commendable, its potential side effects could be significant and far-reaching. It may adversely affect micro and small enterprises, as buyers might opt to procure goods and services from entities not registered under the MSMED Act. It is anticipated that there will be considerable confusion, doubts, and nuances surrounding the new