FAQs on Section 43B: Disallowance of the Amount Payable to MSEs

Introduction

The Income Tax Act allows the deduction of expenses depending on the accounting system followed by the taxpayer. If the taxpayer follows the cash system of accounting, deductions are allowed based on actual payments. However, if the taxpayer follows a mercantile system of accounting, the deduction is allowed on an accrual basis. Section 43B of the Income Tax Act provides a list of expenses that can be deducted based on payments, irrespective of whether the taxpayer follows a trading method. The Finance Act 2023 added an additional item to this list that is Section 43(h), stating that any amount payable to a micro or small enterprise (MSEs) beyond the specified time limit shall be allowed as a deduction in the year in which it is paid. In this blog, we will answer some queries regarding Section 43(h) of Income Tax.

1. Which businesses are classified as micro & small enterprises?

The definitions of micro-enterprises & small enterprises are provided in Section 43B of Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act). The classification is based on factors such as investment in plants and machinery for manufacturing enterprises or equipment for service enterprises.

• Micro Enterprises whose net investment in plant & machinery or equipment is not more than Rs. 1 Cr and annual turnover is not more than Rs. 5 Cr.
• Small Enterprises whose net investment in plant & machinery or equipment is not more than Rs. 10 Cr and annual turnover is not more than Rs. 50 Cr.
• Medium Enterprises whose net investment in plant & machinery or equipment is not more than Rs. 50 Cr and annual turnover is not more than Rs. 250 Cr.

2. How are turnover and investment calculated to categorize enterprises into micro, small, and medium-sized classifications?

The calculation of turnover is based on a net turnover approach, which includes the turnover of goods and services after deducting the exports of goods and services. Likewise, when assessing investment in plants and machinery or equipment, it is evaluated on a net investment basis according to the income-tax return. This involves deducting the depreciated cost of plant and machinery or equipment as per the ITR, along with the expenses related to pollution control, research and development, and industrial safety devices.

Calculation of Investment

The calculation of investment in plant and machinery or equipment will be based on the previous years’ ITR filed under the IT Act. For new businesses without prior ITR, the investment will be based on the promoter’s self-declaration, but this relaxation will cease after the first ITR is filed by 31st March of the financial year. The term “plant and machinery or equipment” will have the same meaning as defined in the Income-tax Rules, 1962, and will include all tangible assets except for land, buildings, furniture, and fittings.

The purchase value of plant and machinery or equipment, whether new or used, will be considered, excluding GST. Certain items specified in Section 7 of the Act will be excluded from the calculation of the investment amount in plant and machinery.

 Calculation of Turnover

The turnover calculation excludes exports of goods or services for all types of enterprises. The turnover and export turnover information is connected to the Income-tax Act, CGST Act, and GSTIN. Enterprises without PAN can provide self-declaration for turnover figures until March 31, 2021, after which PAN and GSTIN become mandatory. The exemption from requiring a GSTIN is based on the provisions of the CGST Act, 2017.

3. What do you mean by “Supplier” as per MSMED Act?

The term “Supplier” is defined in Section 2(n) of the Mirco Small Medium Enterprises Development Act as a micro or small enterprise that has filed a memorandum with the authority referred to in Section 8(1) (Udyam Registration). This definition includes various entities such as the National Small Industries Corporation, Small Industries Development Corporation of a State or a Union territory, and any company, cooperative society, trust, or body registered or constituted under any law engaged in selling goods produced by micro or small enterprises and rendering services provided by such enterprises.

Only micro and small enterprises that are Udyam-registered are considered suppliers for Section 15 of the Micro Small Medium Enterprises Development Act. This means that they are entitled to the right to timely payment, the right to interest on delayed payment, and the right to file a complaint with MSEFC for recovery of dues from the buyer.

4. Does Section 43B(h) apply to suppliers that are not registered?

Non-registered suppliers are not subject to the provisions of Section 43B(h) according to the Mirco Small Medium Enterprises Development Act. Udyam Registration can be filed online without the need for documents or proof, allowing enterprises to establish themselves as Micro Small Medium Enterprises without registration. However, Section 43B(h) references Section 15 of the Mirco Small Medium Enterprises Development Act, which pertains to delayed payment to a “supplier.” The definition of “supplier” in Section 2(n) includes micro or small enterprises that have filed a memorandum with the Udyam Registration Authority. Therefore, without registration, Section 15 may not be applicable under Section 43B of the IT Act.

5. Will the disallowance apply to the amount payable to retail traders or wholesalers?

The recent Office Memorandum issued by the Central Government clarifies that while retail and wholesale trades can be registered on the Udyam Registration Portal as Mirco Small Medium Enterprises, their benefits will be limited to Priority Sector Lending only. Other benefits, such as provisions for delayed payment under the Mirco Small Medium Enterprises Development Act, 2006, are excluded. This means that if a supplier’s Udyam Certificate identifies them solely as a trader, they cannot be considered a “Supplier” for the purposes of section 15 and section 43B(h) unless the Office Memorandum is challenged and overturned in court.

6. Does the disallowance under Section 43B(h) affect the GST component if it is payable to MSE?

The disallowance for Micro or Small Enterprises is limited to the amount excluding GST if the GST is claimed as Input Tax Credit (ITC) in the books of accounts. However, if the buyer chooses not to claim the input tax credit and treats it as an expense, the deduction against GST will only be allowed based on the actual payment made.

7. What is the time limit given under the MSMED Act for making payments?

Section 15 of the Mirco Small Medium Enterprises Development Act sets a time limit for making payments. According to Section 43B(h), the buyer must make payment for goods or services supplied within the agreed-upon date, which cannot exceed 45 days. If there is no agreement, the payment must be made before the appointed day, which is defined as the day after 15 days from the acceptance or deemed acceptance of goods or services by the buyer.

8. How can an assessor decide whether his supplier is a micro or small enterprise?

To decide whether a supplier is a micro or small enterprise (MSE), the supplier should mention their MSE status on supply orders, invoices, letterheads, and other relevant documents. However, if the supplier fails to do so, it becomes challenging for the assessee to identify MSE suppliers, disclose their dues in annual accounts, comply with Section 15, and for auditors to verify the required disclosures. The Government of India recommends that MSEs should include their Entrepreneurs Memorandum (EM) number on their documents to ensure easy identification as an MSE supplier.

In cases where suppliers do not mention their Udyam Registration Numbers on their documents, the assessee and auditors may not be held responsible for non-detection or omission of dues to MSEs. However, it is important to note that the absence of Udyam Registration Numbers on bills, invoices, and correspondence by MSEs may not exempt buyers from their obligations under the Mirco Small Medium Enterprises Development Act or Section 43B. Therefore, buyer entities to request all suppliers to confirm their MSE registration status and provide the Registration Number and a copy of the Udyam certificate. This information should be obtained when placing a purchase order or receiving a sales order to ensure timely payment to registered MSE suppliers.

9. Do suppliers need to update their turnover & investment information regularly on the Udyam Registration Portal?

Udyam Registered businesses are obligated to update their information on the Udyam Registration portal, which includes ITR and GST Return details for the previous financial year, along with any additional required information, through self-declaration. The Udyam Portal automatically retrieves these details from the ITR and GST returns filed on their respective portals, eliminating the need for manual uploads of turnover and investment details. In case of any changes in business activities, entities must promptly update the portal with the new information to avoid suspension of their Udyam Registration status due to a failure to update relevant details online.

10. Is Section 43B(h) applicable to the payments owed for the purchase of Capital Goods?

The applicability of Section 43B(h) is not dependent on the classification of expenditure as capital or revenue. It refers to sums payable that are eligible for deduction under the Act. Section 43B(h) specifically covers payments to micro or small enterprises for the acquisition of capital goods, where a 100% deduction is permitted under Sections 30 to 36.

In cases where a 100% deduction for capital expenditure is not permitted, depreciation on capital goods purchased from an MSE supplier would not be disallowed if payment is delayed, as depreciation does not fall under the category of “sum payable for which deduction is otherwise allowable”.

11. Does the disallowance rule apply to taxpayers who use the cash system of accounting?

The disallowance rule does not apply if the assessee follows a cash system of accounting. According to Section 43B of the IT Act, expenses can only be allowed on a payment basis, regardless of whether the assessee follows a mercantile system of accounting. The cash method of accounting recognizes revenues and expenses only when cash is received or paid out, respectively. This means that income is recorded when cash is received, and expenses are recorded when cash is paid. Therefore, if the assessee already follows a cash basis of accounting, there will be no impact on their situation as they are already recording expenses on a payment basis.

12. In what ways does the recently incorporated clause (h) stand out from the other clauses in Section 43B and what does it offer?

Section 43B refers to outstanding sums paid after the financial year-end, while the new clause (h) focuses on payments to micro or small enterprises beyond the time limit set by the Mirco Small Medium Enterprises Development Act.

Unlike other clauses in Section 43B that allow deductions for year-end outstanding on an accrual basis if paid by the ITR filing due date, clause (h) only permits deductions if payments are made within the timeframe specified in Section 15 of the Mirco Small Medium Enterprises Development Act.

13. A Udyam-registered small enterprise supplier has acquired plant and machinery valued at Rs. 10. crores. Does this significant investment affect the supplier’s classification as a small enterprise?

If a small enterprise supplier registered under Udyam buys plant and machinery worth Rs. 10 crores, their status will be upgraded to a medium enterprise. Even after the change in classification, the entity will continue to receive all non-tax benefits of the small enterprise category for three years.

14. Does Section 43B disallow supplies made before obtaining Udyam registration?

Payments for supplies made before obtaining Udyam registration are not subject to disallowance under Section 43B(h). The individual or entity will be considered a micro-enterprise only from the date of obtaining Udyam registration, as Udyam Registration does not have a retrospective effect.

15. Can the Income-tax Act allow for the deduction of interest payable to Micro/Small enterprises for delayed payments?

According to Section 23 of the MSMED Act, the Income-tax Act does not allow for the deduction of interest payable to Micro/Small enterprises for delayed payments made by buyers.

16. Is Section 43B(h) applicable to outstanding amounts for Capital Goods purchased?

Section 43B(h) is applicable to the amounts owed for the purchase of Capital Goods and its application is not dependent on the classification of the expenditure as capital or revenue. It only applies to amounts that are payable and for which a deduction is allowed under the Act. If a 100% deduction is allowed for amounts owed to MSE suppliers, then Section 43B(h) would come into play and there would be a disallowance for depreciation if the payment is not made on time. However, if a 100% deduction is not allowed, there would be no disallowance for depreciation in case of delayed payment.

17. Does the disallowance apply if the taxpayer chooses a presumptive taxation scheme?

If an assessee chooses a presumptive taxation scheme under Section 44AD, Section 44ADA, Section 44AE, etc., disallowance may not be applicable.

18. If the cheque is given to the MSEs before the due date but if they encash after the due date, what are the implications?

As long as the cheque is not bounced, if it is handed over to the MSEs on or before the due date but encashed after the due date, it will still be considered as payment made within the due date, in accordance with accepted commercial practices.

19. Is disallowance under section 43(h) applicable when calculating book profit for MAT purposes?

Disallowance under Section 43(h) cannot be made while calculating book profit for MAT purposes. Section 43(h) is specifically applicable for calculating taxable business profits of a company in regular assessment under the Act, and it does not apply to the calculation of Minimum Alternate Tax under Section 115JB.

20. Can we identify that the supplier is a micro or small enterprise based on their Udyam Number on the printed invoice?

The Udyam Number printed on the supplier’s invoice does not indicate whether the supplier is a micro, small, or medium enterprise. To determine the classification, the buyer entity must search for the Udyam Registration Certificate in the Udyam portal using the Udyam Number format UDYAM-XX-00-0000000, where XX represents the State, 00 represents the first two letters of the PIN Code, and 0000000 represents the number.

21. Does Section 43B(h) apply to an assessee who is registered as a Udyam-Registered Micro or Small Enterprise?

Buyers who are Micro or Small enterprises are not exempt from Section 43B(h). This provision does not apply exclusively to medium or large enterprise buyers.

22. Are CA firm fees subject to Section 43B(h)?

The Mirco Small Medium Enterprises Development Act and Chartered Accountants Act, 1949 do not prohibit a CA firm from filing Udyam Registration as a micro or small enterprise. Professional services are not excluded from the definition of “service” under the Micro Small Medium Enterprises Development Act. Therefore, a CA firm can apply for Udyam Registration as a micro or small enterprise based on specified turnover and investment criteria.