MSME & Tax24 July 2024By Lexworth Law
The Finance Act, 2023 introduced a significant amendment to Section 43B of the Income Tax Act, 1961, by adding clause (h). This new clause aims to address the timely-payment issues faced by Micro and Small Enterprises (MSEs) in India. Here is a detailed look into the background, implications and specifics of this amendment.
Background and Rationale
Micro and Small Enterprises are crucial to the Indian economy, contributing significantly to employment and GDP. However, these enterprises often face delayed payments from buyers, causing cash-flow issues and financial strain. The existing provisions under the MSMED Act, 2006 mandate buyers to make payments within a specified period or face penal interest. Despite this, delays remained common, prompting the need for stricter measures.
To enforce discipline and ensure timely payments to MSEs, the Finance Act, 2023 introduced Section 43B(h) into the Income Tax Act. This amendment disallows the deduction of expenses incurred towards MSEs if payment exceeds the stipulated period under the MSMED Act, thereby encouraging prompt payment.
Key Provisions of Section 43B(h)
Section 43B(h) specifically targets payments made to micro or small enterprises beyond the prescribed time limits. Under the MSMED Act, payments to MSMEs should as a rule be made within 15 days if no specific period is agreed, or within the agreed period, not exceeding 45 days. If the buyer fails to comply:
- Disallowance of deduction — any payment made to a micro or small enterprise beyond the stipulated period will not be allowed as a deduction in the year the liability is incurred. The deduction is allowed only in the year the actual payment is made.
- Non-applicability of general provisions — unlike other expenses under Section 43B, which can be claimed if paid before the due date of filing the return, this relaxation does not apply to clause (h). The deduction is strictly disallowed if the MSMED payment terms are violated.
Coverage and Exceptions
The amendment applies exclusively to micro and small enterprises as defined under the MSMED Act:
- Micro enterprises — investment in plant and machinery or equipment not exceeding ₹1 crore and annual turnover not exceeding ₹5 crores.
- Small enterprises — investment not exceeding ₹10 crores and annual turnover not exceeding ₹50 crores.
Medium enterprises are not covered. Traders are explicitly excluded from the benefits of the MSMED Act, so Section 43B(h) does not apply to them.
Impact on MSMEs
The amendment aims to improve the financial health of micro and small enterprises by ensuring they receive timely payments. Improved cash flow alleviates working-capital pressure and enables better financial planning; reduced financial stress lowers dependency on high-interest short-term credit. In the short term, MSEs can expect a significant improvement in operational liquidity, allowing them to reinvest and enhance productivity.
Practical Scenarios and Compliance
To comply with Section 43B(h), taxpayers and auditors must be vigilant about payment timelines. For instance, if a taxpayer receives goods or services from an MSE on 15 June 2023 and the agreed payment period is 45 days, payment must be made by 30 July 2023 to claim the expense in the same financial year. Delays beyond this period result in disallowance until the payment is made. Auditors must ensure that sundry creditors' outstanding balances as at 31 March are reviewed to confirm that no payments due to MSEs are beyond the permissible period.
Reporting by Auditors in Form 3CD
Compliance is reported in Form 3CD, the statement of particulars required under Section 44AB. Clause 26 specifically deals with unpaid amounts covered under Section 43B, which now includes clause (h). Auditors are expected to identify creditors classified as micro or small enterprises (through declarations or confirmations), verify the agreed payment terms do not exceed 45 days, scrutinise payment records against those timelines, and report any amounts paid beyond the permissible period under Clause 26 as disallowed under Section 43B(h) — noting the year of actual payment where applicable.
In their comments, auditors should record instances of non-compliance, the impact of disallowances on tax computation, and recommendations for improvement such as better payment tracking or renegotiated terms. Meticulous documentation supports transparency and helps the taxpayer avoid penalties.
Stakeholder Perspectives
Government. The provision formalises discipline in the payment ecosystem; by disallowing deductions for delayed payments, it instils responsibility among larger buyers and is expected to reduce the burden of payment-delay disputes on the legal system.
Businesses. Larger companies must reassess payment cycles and cash-flow strategies. While this may cause initial strain for those accustomed to longer cycles, promoting timely payment builds stronger, more trustworthy relationships with MSE suppliers.
Micro and small enterprises. For MSEs the amendment is a much-needed relief — timely payments boost confidence in dealing with larger enterprises and support growth, while promoting better financial discipline through predictable inflows.
Financial institutions. Banks may see reduced demand for short-term working-capital loans from MSEs as cash flows improve, shifting the focus of financial products toward growth and expansion rather than immediate liquidity.
Potential Challenges and Recommendations
The amendment increases the administrative burden of tracking timelines, can strain the cash flow of businesses used to extended credit, and requires awareness and training across finance teams and auditors. To address these, businesses should implement robust payment and accounting systems, conduct regular training, maintain clear communication with MSE suppliers on payment terms, and revisit financial planning to build in buffer periods for processing.
Conclusion
Section 43B(h) is a critical step towards safeguarding the interests of micro and small enterprises in India. By mandating timely payments it supports the financial stability of MSEs and fosters a culture of prompt payment. Businesses and auditors must adapt to ensure compliance and avoid disallowances. If successfully implemented, the provision could set a precedent for further reforms supporting the MSME sector — and, over time, a more disciplined and reliable payment ecosystem across the economy.
This note is for general information only, may reflect the law as it stood at the date of writing, and does not constitute legal advice. For advice on a specific situation, please seek independent counsel.
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