Introduction
The Finance Act of 2023 has introduced a significant amendment to the Income Tax Act, specifically Section 43B(h), which directly affects Micro, Small, and Medium Enterprises (MSMEs) and their clients. This amendment, coming into effect from April 1, 2024, pivots on the critical issue of payment timelines and the subsequent tax deductions for sums payable to MSMEs.
Understanding the Amendment
The newly inserted Section 43B(h) stipulates that any sum payable by an assessee to a micro or small enterprise that is beyond the timeframe outlined in Section 15 of the MSMED Act, 2006, can only be claimed as a tax deduction upon actual payment, irrespective of the accounting year in which the liability was incurred. The intent is to mitigate the challenge of working capital scarcity in MSMEs by encouraging timely payments.
Classification of MSMEs
As per the MSMED Act, enterprises are classified into micro, small, and medium categories based on investment in plant and machinery or equipment (Micro- Investment in Plant & Machinery less than 1Cr and Turnover up to 5 Cr and Small- Investment in Plant & Machinery less than 5Cr and Turnover up to 50 Cr) and annual turnover excluding Export Turnover. The amendment in question, however, applies exclusively to micro and small enterprises, leaving out medium-sized enterprises as well as traders who, although may be registered as MSMEs, do not fall under the 'enterprise' definition in this context.
For MSME Suppliers:
Documenting MSME Status: It is imperative to disclose MSME status on supply orders and invoices. This ensures buyers are aware of and adhere to payment timelines.
Communicating Registration: MSME suppliers must proactively inform buyers of their registration, allowing for correct tax treatment of payments.
Advance Payments: These will be recognized as a deduction in the year they are received, providing an advantage in terms of cash flow and tax planning.
For Buyers of MSME Services and Products:
Compliance with Payment Deadlines: Buyers must make payments within the statutory period (15 days from acceptance or as per agreement, not exceeding 45 days). Non-compliance will lead to tax disallowances.
Checking Supplier Credentials: Buyers should verify the MSME status of suppliers for correct application of tax provisions.
Tax Deduction and Timing: Payments made after the prescribed period but within the financial year can be claimed as deductions in that year. However, payments made in the subsequent year can only be deducted in the year of payment, not accrual.
Implications and Practical Considerations
Penalties for Late Payment: Late payments will not be eligible for deductions in the year the expense is incurred, aligning with the principle that cash outflow is a prerequisite for expense recognition in tax computations.
Disallowance of Interest: Any interest paid to MSMEs for delayed payments is not deductible under the Income Tax Act.
Prospective Application: Amounts outstanding as of March 31, 2023, are not affected; the amendment is forward-looking from the start of FY 2024-25.
Non-Applicability to Medium Enterprises: The focus is on protecting micro and small enterprises, ensuring they receive their dues in a timely manner to maintain liquidity.
Capital Expenditures: Since capital expenditures are generally not deductible expenses, late payment related to these does not attract disallowance under Section 43B(h).
Conclusion
The amendment to Section 43B(h) underscores the importance of timely payments to MSMEs, not just as a good business practice but also as a compliance requirement with direct tax implications. Both suppliers and buyers need to be aware of these changes and adapt their business processes and accounting practices accordingly. Seeking professional advice from an experienced Chartered Accountant for proper interpretation and application of these rules is highly recommended to avoid any unintended tax consequences.
Navigating these changes effectively will be key to sustaining strong business relationships between MSMEs and their clients and contributing to a healthier, more cash-flow-positive ecosystem for the nation's critical small and micro business sectors.