Breaking Down Section 43B for MSMEs

Impact Analysis of Section 43B(h) Amendment on timely Payments to MSME

• Micro, Small, and Medium Enterprises (MSMEs) are the backbone of India’s economy, playing a pivotal role in creating jobs and contributing to GDP.
• Finance Minister Nirmala Sitharaman has emphasized the critical role of MSMEs in India’s economy and reaffirmed the government’s dedication to ensuring their financial stability through timely payments.
• However, the tax landscape can be daunting, particularly when it comes to navigating key provisions like Section 43B of the Income Tax Act. Here’s a detailed guide to help MSMEs understand and benefit from this critical section.
• The timely payment rule under Section 43B(h) is a significant step toward creating a supportive ecosystem for MSMEs, fostering their growth and contribution to India’s economy.

What is Section 43B of the Income Tax Act?

• Section 43B mandates that certain business expenses are eligible for tax deductions only when the payment for these expenses is made. This ensures businesses cannot claim deductions for unpaid liabilities.

Eligible Expenses Under Section 43B:

• Employee Provident Fund (EPF)
• Employee State Insurance (ESI)
• Taxes and Duties (e.g., GST, TDS, excise duties)
• Interest on Loans (including working capital loans)
• Bonus and Gratuity payments to employees
• Leave Encashment and other employee-related benefits

Other Important Notes on Eligible Expenses Under Section 43B

• Section 43B: Allows deductions for certain statutory liabilities on a payment basis, including employer contributions to PF/ESI, taxes, leave encashment, and bonuses. Payment must be made by the due date of filing the return (Section 139(1)).
• LIC Mutual Fund Not a Public Financial Institution; Interest Payable Not Covered Under Section 43B.
• Interest Payable on Loan Taken from State Govt. or World Bank Not Covered Within the Provision of Section 43B
• Clause 26 under the tax audit (Amounts covered Section 43B) In this Tax audit clause, after (g), the word (h) of section 43B has been added.

New Rule Highlights under Section 43B(h)

• Mandated Payment Timeline: Introduced under Section 43B(h) of the Income Tax Act by the Finance Act 2023. Require payments to MSMEs to be made within 45 days of the transaction.
• Tax Implications for Non-Compliance: Payments delayed beyond 45 days will become ineligible for tax deductions. Outstanding amounts will be added to the company’s taxable profits, increasing the tax burden.

Big Question : whether Creditor is an MSME?

Many people are confused about how to check whether a creditor is an MSME and whether its financials need to be reviewed. However, it has been clarified in this blog on Tax Audit that only a Udyam-registered micro or small enterprise must be considered for section 43B(h)

What Businesses Should Do- Best Practices for MSMEs?

• Review contracts and align payment terms with the 45-day rule and Adjust Payment Policies
• Regularly track payments to MSME vendors to avoid tax penalties.
• Leverage platforms like TReDS for early invoice discounting and maintaining cash flow.
• MSMEs is required to ensure that payments for EPF, ESI, taxes, and other dues are made within statutory deadlines. For deductions, payments must be completed by the ITR filing due date.
• Micro, Small, and Medium Enterprises are required to make Financial Planning – Plan cash flow to ensure funds are available for statutory payments. Allocate resources for liabilities like loan interest and employee benefits.
• Ensure employees and stakeholders understand the implications of the rule.
• MSMEs is required to maintain clear records of expenses and payments to simplify compliance and tax filing. Implement systems to track due dates and payments.
• MSMEs should Set Reminders for Payment Deadlines: Use tools or software to track statutory payment due dates.
• Micro, Small, and Medium Enterprises must fixed Budget for Liabilities & Allocate funds monthly or quarterly to avoid last-minute cash flow crunches. And also Keep updated on any amendments to Section 43B or related provisions.
• Timely payments not only reduce the tax burden but also help in better financial planning and cash flow management. With proper practices in place, MSMEs can turn this provision into an opportunity for growth and sustainability.

Significance of Section 43B for MSMEs

Section 43B requires businesses to pay statutory liabilities to claim deductions, promoting timely payments and better compliance. Micro, Small, and Medium Enterprises can claim deductions in the year of payment, providing relief for those struggling with cash flow constraints. Even if payments are not made during the financial year, they can still qualify for deductions if made before the due date for filing ITR.  By linking tax deductions to payments, the provision nudges MSMEs to manage their finances efficiently.

Rationale Behind the Rule

• Addressing MSME Challenges i.e Late payments disrupt MSME cash flow, hindering operations and growth.
• This rules is encourages timely settlements in business transactions. Aligns with broader government efforts to support MSME sustainability.
• Complements initiatives like the Trade Receivables Discounting System (TReDS), which helps MSMEs receive payments promptly at competitive rates.

Some examples for applicability of Section 43B(h) in different cases

Where the agreement is in writing

Where there is no agreement in writing

Impact on Tax Filing for MSME’s

Section 43B plays a significant role during tax filing. Expenses that are incurred but unpaid cannot be deducted, emphasizing the importance of timely payments. Non-compliance can lead to:

• Loss of valuable tax deductions.
• Increased taxable income, resulting in a higher tax liability.
• Penalties and interest on delayed statutory payments.

Revision in classification criteria for MSMEs