Corporates, non-corporates, or government departments are all procuring major parts of services or goods from MSMEs. There are provisions under the Micro, Small, and Medium Enterprises Development (MSMED) Act to ensure that businesses make payments to MSMEs within a specified time frame, and failure to do so can impact the deduction claims for such payments.
To facilitate timely payments to micro, small, and medium enterprises (MSMEs) and address the challenges faced by these businesses in recovering their dues, the Finance Bill, 2023, proposed to insert a new clause (h) in Section 43B of the Act to provide that any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in Section 15 of the MSMED Act shall be allowed as a deduction only on actual payment.
Section 15 of the MSMED Act provides
"In the case of written agreements, payments due to MSMEs should be made within the time frame agreed upon between the parties, which cannot exceed 45 days. In the absence of a written agreement, these payments must be made within 15 days from the due date."
Section 43B of the Income Tax Act provides that deductions for certain sums specified in clauses (a) to (g) are allowable only on actual payment. However, the proviso to this section allows deductions on an accrual basis if the specified sum is paid by the due date of furnishing the return of income. The section and the proviso thereto read together provide that a deduction is allowable if the actual payment is made by the due date for furnishing the return of income. But so far as the sum covered by the proposed clause (h) is concerned, the payment of the principal sum due to a micro and small enterprise must be made within the time limit specified in Section 15 of the MSME Act so as to qualify for deduction.
Let us take a look at some practical situations that outline the eligibility to claim deductions for MSE vendor payments as per the new clause addition. For the following illustration, it is assumed that there is a predefined written agreement.
Illustration 1: Kumar & Sons made a payment of expenses incurred in PY 2022–23 to a MSE after the time limit set by Section 15 of the MSMED Act, 2006, but within the same financial year, i.e., before March 31, 2023.
In this situation, Kumar & Sons settled the payment after the specified time limit of Section 15 of the MSMED Act, 2006. But since the payment was made within the same financial year that the expense was accrued, deductions shall be allowed in that financial year, 2022–23.
Illustration 2: Y & Co. completes payment to a MSE within the time limit specified under Section 15 of the MSME Act, 2006, and during the same financial year that the expense is accrued.
The provisions of Section 43B of the Act would not apply to the payment that Y & Co. made to the MSE. A deduction is allowed in the financial year in which the expense was accrued.
Illustration 3: Z Ltd. dealt with an MSE where he had expenses that accrued in March 2024 but were paid to the vendor during the subsequent financial year in April 2024, within the time specified under Section 15 of the MSMED Act, 2006.
In this situation, Z Ltd. made the payment as per the time limit specified under Section 15 of the MSMED Act, 2006. Thus, the payment will be allowed as a deduction while taxable income is calculated on an accrual basis in the financial year 2023-2024.
Illustration 4: A Ltd. had an expense payable to an MSE that accrued in the financial year 2023-2024 but was settled in the subsequent financial year 2024-25 after the time limit prescribed under Section 15 of the MSMED Act, 2006.
In this case, as the payment is made beyond the time limit as prescribed under Section 15 of the MSMED Act 2006 and also in the subsequent year 2024–25, A Ltd. will not be eligible for deduction of the said payment in the financial year 2023–2024 when the expenses accrue. The deduction of this payment is allowed in FY 2024–25, in which it is actually paid.
Illustration 5: XYZ Ltd. dealt with an MSE where it received an invoice dated March 15, 2024, with respect to the supply of goods delivered on the same day. XYZ Ltd., having an issue with regards to the quality of goods supplied, communicated the same to the MSE vendor on March 18, 2024. Both parties reached a conclusion with regards to the dispute on April 30, 2024, and accordingly, XYZ Ltd. made a payment on May 31, 2024.
In this scenario, as a dispute with regards to the invoice was communicated within 15 days of the date of delivery, the time limit under Section 15 of the MSMED Act 2006 is applicable from the date on which the dispute is resolved. And accordingly, the payment is made within 45 days from the date on which the dispute was resolved. XYZ Ltd. will be eligible for deduction of the said payment in the financial year when the expenses accrue.
Payment of Interest to MSMEs
Section 23 of the MSMED Act provides that where the assessee is liable to make payments of interest under or in accordance with the provisions of the MSMED Act, no deduction shall be allowed to the assessee for such payments for calculating taxable income under the Income Tax Act. As payment of such interest is considered penal in nature, no deduction is allowed under Section 37 of the Income Tax Act.
It is critical to adhere to the relevant regulations and requirements under the Income Tax Act and the MSMED Act. Non-compliance with the law may lead to the disallowance of expenses and increase the tax burden under the Income Tax Act. It is advisable to seek professional help to check compliance to avoid repercussions.
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