Income Tax deduction for procurements from MSMEs only upon actual payment

By Shaleen Shah | LinkedIn, assisted by Divyansh Jain

Introduction

This Note is relevant to computation of income under the head ‘Income from business and profession’.

Section 43B of the Income Tax Act provides a list of expenses allowed as deduction, on cash basis irrespective of the year of accounting. It lists some expenses that can be claimed as deduction from the business income only in the year of actual payment and not in the year when the liability to pay such expenses is incurred. Few examples of such listed expenses are taxes & duties like GST, customs, etc., employer’s contribution to PF, gratuity fund, etc., bonus payable to employees, interest on bank loans, etc.

Let us understand this by way of an illustration. M/s ABC is a partnership firm and have made an accounting entry for staff Bonus provision on 31st March 2023. The Firm filed its ITR in July 2023 and paid Bonus to the staff during Diwali which was in November 2023. So, deduction for Bonus will be taken in books in FY 2022-23. However, while computing Business Income as per Income Tax, since this Bonus is not actually paid before filing the ITR, it will not be allowed as a deduction. The deduction will be available while computing Business Income for FY 2023-24 which is the actual year of payment.

To this list of expenses, another item is added from FY 2023-24. Any sum payable by the assessee to a micro or small enterprise beyond the time-limit specified in Section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) shall be allowed as deduction from the Business Income only in the year of actual payment and not in the year when the liability to pay such expenses is incurred.

Since several sections of the Income Tax Act & MSMED Act come into play in interpreting this provision, in this Note we have first provided the relevant provisions. Thereafter, we have prepared a Gist explaining the actual impact & action points.

Income Tax Act

Section 43B. 

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

(h) any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006), shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him:

Provided that nothing contained in this section except the provisions of clause (h) shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return.

MSMED Act

Section 15.   Liability of buyer to make payment.

Where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day:

Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance.

Section 16.   Date from which and rate at which interest is payable.

Where any buyer fails to make payment of the amount to the supplier, as required under section 15, the buyer shall, notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the Reserve Bank.

Section 23.   Interest not to be allowed as deduction from income.

Notwithstanding anything contained in the Income-tax Act, 1961 (43 of 1961), the amount of interest payable or paid by any buyer, under or in accordance with the provisions of this Act, shall not, for the purposes of computation of income under the Income-tax Act, 1961, be allowed as deduction.

Section 2.   Definitions.

(b) “appointed day’ means the day following immediately after the expiry of the period of fifteen days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier.

Explanation.–For the purposes of this clause,–

(i) “the day of acceptance” means,–

(a) the day of the actual delivery of goods or the rendering of services; or

(b) where any objection is made in writing by the buyer regarding acceptance of goods or services within fifteen days from the day of the delivery of goods or the rendering of services, the day on which such objection is removed by the supplier;

(ii) “the day of deemed acceptance” means, where no objection is made in writing by the buyer regarding acceptance of goods or services within fifteen days from the day of the delivery of goods or the rendering of services, the day of the actual delivery of goods or the rendering of services;

Gist of the aforesaid provisions

1. Credit Period: Payment to MSME suppliers must be made within mutually agreed credit period in writing OR 45 days of receipt of goods or services, whichever is earlier. If there is no pre-agreed credit period in writing, 15 days will be deemed to be the credit period.
2. Interest beyond credit period: If payment is not made to the MSME supplier within the credit period, interest will have to be paid as per Section 16 of MSMED Act. This interest will be disallowed for computing income as per the Income Tax Act.
3. Unpaid amount to Micro or Small enterprises on 31-March must be paid within the credit period to claim deduction for the said expenditure in the year of accounting. If the unpaid amount on 31-March is paid after the credit period, the deduction for the expenditure will be allowed in the year of payment.
4. If there is a dispute or objection pertaining to receipt of goods or services, objection must be made in writing within 15 days of such receipt of goods or services. The period from the date of such written objection until it is resolved shall be excluded.
5. It is important to note, that, unlike other expense items listed in Section 43B, the payment made to MSME vendors after end of the financial year, but before filing ITR would not be allowed in the year in which liability was incurred. It would be allowed only in year of payment.
6. These provisions are applicable to Corporates (i.e. Companies & LLPs) as well as Non-Corporate (i.e. Partnership, Proprietorship, etc.) businesses. These provisions are also applicable for MSME-to-MSME.

Action Points

• It will be imperative for assessees who have Business or Professional Income to obtain latest Udyam Certificate from all suppliers who are MSMEs in Micro & Small categories.
• Detailed disclosures relating to suppliers registered under MSMED Act are to be made by both Corporate & Non-Corporate businesses in the financial statements.
• Corporates are also required to file particulars of all current outstanding dues in Form MSME-1 with the ROC every six months.