Important Amendments in Income Tax Act, 1961 relating to MSMEs

MSMEs are considered the backbone of the Indian economy and the present Government has been making efforts for building an ecosystem for promoting the sustainable growth of MSMEs. The reason is that the MSMEs are the main source of employment generation through more than 60 million MSMEs employing over 110 million people across the country. MSMEs act as a key supplier chain for large manufacturing units. The share of the MSME sector in the GDP is up to 40%.

The Government in recent years has made several changes in the laws relating to MSMEs namely:

• Introduction of Udyam Registration
• Revising the definition of MSMEs
• Mandatory reporting of MSME dues under the Companies Act

But in this article, we will discuss an important change made by the Government in the Income Tax law in relation to MSMEs. This amendment has a far-reaching impact on the business community and will substantially increase the compliance burden upon them. However, if understood in its true essence, the said amendment will certainly help MSMEs in overcoming their financial burdens.

Change in the Budget 2023 relating to MSMEs

Generally, the accrual or due basis of the system is followed for accounting of the business entities. However, Section 43B of the Income Tax Act,1961 provides for certain deductions to be allowed only on the actual payment basis. Further, the proviso of this section allows deduction on the accrual basis, if the amount is paid by the due date of furnishing the income tax return.

A new clause has been inserted in the Section 43B of the Income Tax Act, 1961 relating to outstanding dues to MSMEs as follows:

Note: The above amendment is effective from 01-04-2024 i.e. A.Y. 2024-25 and onwards.

In simple words, the above amendment states that any amount outstanding at the year-end to a micro or small enterprise should be paid by the assessee before the time limit as specified in section 15 of the MSMED Act, 2006. In case of failure, such an amount shall not be allowed as a deduction in that financial year but in the year in which such an amount is actually paid.

Thus, the deduction for the amount outstanding to the micro and small enterprises shall now be allowable on an actual payment basis and not on an accrual basis. For better understanding, we need to know what is a micro or small enterprise and what is the time limit under section 15 of the MSMED Act.

Classification of MSMEs

MSME means micro, small, and medium enterprises. The Central Government has given a classification criterion for MSMEs w.e.f. 01-07-2020 which is as below:

Classification criteria for MSMEs are based on the quantum of investment and turnover. If an entity fulfills both these criteria, it will be classified as a micro/small/medium enterprise as the case may be. The MSME entity needs to obtain “Udyam Registration” (earlier Udyog Aadhar) for taking benefits of various MSME schemes of the Government.

Earlier, only manufacturing entities & service providers were eligible to obtain “Udyam Registration.” Later, the Government issued Circular No. 5/2(2)/2021-E/P&G/Policy dated 02^nd July 2021 allowing traders also for obtaining “Udyam Registration”.

Time limit under section 15 of MSMED Act

Where any supplier, supplies any goods or renders any services to any buyer, the buyer shall make payment thereof;

• 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 (15 days read below).

Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed 45 days from the day of acceptance or the day of deemed acceptance.

Appointed Day under MSMED Act

According to Section 2(b) of the MSMED Act, 2006, “Appointed Day” means the day following immediately after the expiry of the period of 15 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,

• “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 the acceptance of goods or services within 15 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.

• “The Day of Deemed Acceptance” means, where no objection is made in writing by the buyer regarding the acceptance of goods or services within 15 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;

Now summing up the amendment made in the Income Tax Act with a reading of the MSMED Act:

• Any overdue amount to micro and small enterprises, by any assessee as of 31^st March of a year should have been paid on or before 31^st March i.e. the amount outstanding in the Balance Sheet as payable on 31^st March should not be beyond the due date as mentioned in Section 15 of MSMED Act (15 days/45 days).

• If any amount remains outstanding beyond 15 days/ 45 days as of 31^st March of a year, such amount (expenditure) will not be allowed in that year. Such expenditure will be added back to the income of the assessee thus leading to a higher tax outflow. Such overdue (disallowed) amount shall be allowed to the assessee in the year in which it is actually paid by him.

• Any overdue amount to medium enterprises shall not be affected by the said amendment as newly inserted clause (h) to section 43B is applicable only in case of overdue relating to micro and small enterprises.

Conclusion: The Finance Act 2023 has brought the above amendment in the Income Tax Law with the objective to promote timely payments to MSMEs. Thus, if a person is procuring goods or services from an MSME entity, he will be obliged to make timely payments to MSMEs to avoid disallowance of expenditure under the Income Tax. This will bring financial stability to MSMEs and reduce their working capital requirements.

Hence, every assessee procuring goods or services from MSMEs should be diligent w.e.f. 1^st April 2023 and should keep in mind that deductions for the amount payable to MSMEs will only be allowed when it is actually paid. Strict adherence to 15 days/ 45 days’ time-limit for payments to MSMEs should be ensured especially on the amount outstanding at the year's end to avoid disallowances under Section 43B of the Income Tax Act.

Disclaimer: The above article is meant only for educational purposes and does not carry any persuasive value. Therefore, the readers are advised to act in consultation with any professional before applying the information contained in this article. Taxwink is not responsible for any loss or damage caused to any person on account of any information contained in this article.

About Author: The article is contributed by CA Naveen Goyal who is a qualified Chartered Accountant with an experience of over 16 years in the field of Direct & Indirect Taxes. He is a prolific writer with a zeal to share knowledge on various issues pertaining to taxation laws in India. He can be reached at: ca.naveen80@gmail.com