[Opinion] Finance Bill 2023 – Paving self-reliant trajectory for MSMEs

Authored by Piyush Mohan Thakur, Banu Chander & Shreeya Gupta | Chartered Accountant

The Union Budget 2023 provided the blueprint for steering the economy towards a sustainable high-growth trajectory. Amongst the various tax proposals which aimed to strengthen the Indian economy, one of the most appreciated steps is to encourage timely payments to Micro and Small Enterprises by including the same within the ambit of Section 43B of the Income tax Act, 1961 (‘Act’). This will result in ensuring effective working capital management by Micro and Small Enterprises, which are backbone to Indian economy.

Currently, payments to Micro, Small and Medium Enterprises (‘MSMEs’) registered under Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act, 2006’) are vicariously hedged by disallowing the interest paid in case of delayed payment to MSMEs while computing the taxable income under section 23 of the MSME Act, 2006.

With an intent to further strengthen the MSME ecosystem, the Finance Bill, 2023 has proposed an amendment to Section 43B and inserted clause (h) in Section 43B of the Act to provide that any sum payable by the assessee to a micro or small enterprise registered under MSME Act, 2006 would be allowed only on actual payment basis

It is further clarified by the amendment that in case of payments made to micro or small enterprises, the proviso that allows deduction of the expenses mentioned in Section 43B if the payment for the said expense is made on or before the return filing date, shall not be applicable for the payment to micro and small enterprises. Further, it is also clarified that the sum payable to micro and small enterprise can be allowed on accrual basis only if the same is paid within the due date specified under section 15 of MSME Act, 2006.

Section 15 of the MSME Act, 2006 provides that payment to micro and small enterprises should be made within the time limit specified in the written agreement, and such time limit should not exceed 45 days. However, if there is no agreement, then the payment shall be made within the appointed date prescribed under MSME Act, 2006 (i.e., 15 days from specified event).

It is pertinent to note that Section 43B is attracted only when the payment is made to ‘micro’ or ‘small’ enterprise registered under MSME Act, 2006 and does not include ‘medium’ enterprises registered under MSME Act, 2006. The difference as specified in MSME Act, 2006 between Micro, Small and Medium enterprises as applicable to entities involved in Manufacturing / service sector is tabulated below:

Further, the proposed amendment may lead to various scenarios which are illustrated below:

Scenario 1: Payment to micro or small enterprise within the time limit prescribed under section 15 of MSME Act, 2006 and in the financial year in which the expense is accrued/incurred:

Such payments would not be covered by the provisions of section 43B of the Act and shall be allowed as deduction as per provision of the Act in the financial year in which the expense is accrued/incurred.

Scenario 2: Payment to micro or small enterprise made beyond the time limit prescribed under section 15 of the MSME Act, 2006 but in the financial year in which the expense is accrued:

In this scenario, since the payment is made beyond the time limit, the provisions of Section 43B are triggered. However, the payment is made in the same financial year in which the expense is accrued and accordingly, deduction can be allowed in the said financial year as per section 37 read with section 43B of the Act.

Scenario 3: Expense accrued in the financial year and paid in the subsequent financial year but within the time limit prescribed under section 15 of the MSME Act, 2006:

In this scenario, since the payment has been made within the time limit prescribed under section 15 of MSME Act, 2006, the expense would be allowed in the year of accrual.

Example: If any expenses which are accrued in the month of March (i.e., last month of the financial year) and the payment against the same is due in the month of April (i.e., first month of the next financial year) and is paid within the said time. The said payment will be allowed in the tax computation on accrual basis in the first financial year as the same is paid within the due date prescribed under the law.

Scenario 4: Expense accrued in the financial year and paid in the subsequent financial year but not within the time limit prescribed under section 15 of the MSME Act, 2006:

In this scenario, as the payment is made beyond the time limit as prescribed under section 15 of the MSME Act 2006 and also in the subsequent year, the deduction of the said payment cannot be allowed in the financial year in which the expenses are accrued.

Can the allowance of the said expenses be claimed in the subsequent year in which the payment is made?

As per section 43B, expenses which are disallowed in the year during which they were accrued due to non-payment within the time allowed, can be claimed in the subsequent year when the same are actually paid. Therefore, applying the same rationale the payment to micro or small enterprises which are made in subsequent year and after the time limit prescribed under section 15 of the MSME Act 2006, can be claimed in subsequent year.

Also, in cases where expenses are accrued without complying with the provisions of tax deduction at source (TDS) in a financial year and paid in the subsequent financial year, one needs to closely track the interplay between the disallowances/allowances involving section 40(a)(ia) and section 43B of the Act.

The proposed amendment in section 43B by Finance Bill 2023, would ensure timely payments to the micro and small enterprises, leading to better working capital management. However, on the flipside, the amendment may also pose a negative consequence for assessee(s) who are making contractual payments to these entities, as the proposed amendment necessitates establishment of robust mechanism to monitor various due dates while making payments to multiple micro and small enterprises to avoid the disallowance of huge amounts. This would lead to a cumbersome exercise of closely tracking the disallowances and allowances in subsequent year(s) to comply with the provisions of the Act thereby saddling the assessee(s) with higher operational costs.