Payment to MSME

 The recent Union Budget 2023 has made headlines due to its unprecedented inclusion of payments to Micro and Small Enterprises (MSE) vendors within the ambit of Section 43B of the Income Tax Act 1961. This inclusion is a significant step towards streamlining the payment receipt process for MSE ventures, which make up a fundamental segment of the Indian business ecosystem.

Delayed payments to MSMEs in India have resulted in approximately Rs 10.7 lakh crore being held up, which represents around 6% of India’s Gross Value Added (GVA) for the financial year 2020-21. The addition of the MSE payments clause (h) in Section 43B can prove to be a cornerstone amendment to address this issue.

Section 43B contains provisions pertaining to “Income from Business and Profession,” and lists all the expenses a given business entity can seek as deductions from their business income only in the financial year when they make the actual payment, disregarding the year when the entity incurred such expenses. This provision advocates the deduction of spending on an actual payment basis.

According to the latest Finance Bill 2023, businesses dealing with MSE suppliers need to comprehend the applicability of the amended Section 43B on their payments and pay attention to the requirements of Section 15 of the Micro, Small, and Medium Enterprises Development Act (MSMED), 2006. The amendment permits the deduction of expenses paid to MSEs in line with Section 43B only when it abides by the time limit specified in Section 15 of the MSMED Act 2006. Businesses can claim a deduction on payment to MSE vendors if they are paid within 15 days in cases where there is no agreement or 45 days or as per the time period in a pre-defined written agreement, whichever comes first.

To clarify the appropriate treatment of payments made to MSE vendors in different circumstances, let us look at some practical situations assuming there is a predefined written agreement:

Illustration 1: A made a payment to an MSME after the time limit set by section 15 of the MSMED Act, 2006, but within the same financial year in which the expense was incurred. In this situation, a deduction shall be permitted in that financial year as outlined by the regulations of the Income Tax Act, of 1961.

Illustration 2: B completes payment to an MSME within the time limit specified under section 15 of the MSME Act, 2006, and during the same financial year that the expense is accrued. In this situation, B will be permitted to get a deduction in the financial year in which the expense was accrued.

Illustration 3: C dealt with an MSME where they had expenses that accrued in March 2024 but paid the vendor during the subsequent financial year in April 2024, within the deadline specified under section 15 of the MSMED Act, 2006. In this scenario, the payment will be permitted in C’s tax calculation on an accrual basis in the financial year 2023-2024.

Illustration 4: D had an expense payable to an MSE that accrued in the financial year 2023-2024, but they settled it in the the subsequent financial year 2024-25 after the time limit prescribed under section 15 of the MSMED Act, 2006 ended. In this scenario, D will not be eligible for deduction of the said payment in the financial year 2023-2024 when the expenses accrued.

Illustration 5: E dealt with an MSE where they received an invoice dated 16 March 2024 with respect to supply of goods delivered on the same day. E had an issue with the quality of goods supplied and communicated the same to the MSE vendor on 18 March 2024. Both parties reached