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Non-Payment to MSME and Disallowances of Expenses

Updated: Mar 24

The Income Tax Act of 1961 provides for disallowance of certain expenses incurred by businesses in case of non-payment to Micro, Small, and Medium Enterprises (MSMEs). This provision was introduced to ensure that MSMEs receive their payments in a timely manner and to encourage prompt payments by larger companies. In this article, we will discuss the disallowance of expenses under the Income Tax Act on account of non-payment to MSMEs.

What is MSME?

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of the Indian economy. They contribute significantly to the country's GDP and employment generation. These businesses are classified based on their investment in plant and machinery or equipment and turnover.

Important provisions of MSME Act

Time limit for payment:

(a) Date agreed upon; or (b) 45 days from the date of acceptance or deemed acceptance,

whichever is earlier


Section 15 of the Micro, Small and Medium Enterprises Development Act, 2006, states that 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.

Interest Payable on Delayed Payment

Section 16 of the Micro, Small and Medium Enterprises Development Act, 2006, states that 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.


Disallowance of Expense

Section 23 of the Micro, Small and Medium Enterprises Development Act, 2006, states that 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.

Disallowances as per Income Tax Act, 1961

A new sub section 43B(h) was added w.e.f. AY 2024-25 (FY 2023-24) in the Income Tax Act, 1961, which provides that notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of 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, 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”;

For instance, if a company has obtained services from a Micro & Small enterprises and has not made the payment within the specified period, then in such case, the expense booked in books on account will not be allowed as a deduction under the Income Tax Act till the year it is actually paid.

Illustration

Invoice Date

Date of Acceptance/Deemed Acceptance

Due Date, say

Payment Date

Remarks

1

20-06-2023

20-06-2023

04-08-2023

31-07-2023

Expense Allowed in FY 23-24

2

20-06-2023

20-06-2023

04-08-2023

31-03-2024

Expense Allowed in FY 23-24

3

20-06-2023

20-06-2023

04-08-2023

01-04-2024

Expense Disallowed in FY 23-24 and Allowed in FY 24-25

4

01-03-2024

01-03-2024

15-04-2024

05-04-2024

Expense allowed in FY 23-24

5

01-03-2024

01-03-2024

15-04-2024

20-04-2024

Expense Disallowed in FY 23-24 and Allowed in FY 24-25

6

20-06-2023

20-06-2023

04-08-2023

Unpaid

Expense not allowed till the year it was actually paid

Note: In case, interest payments are made as per provisions of MSME Act for delay in payments then in such case interest expense shall not be allowed in Income tax.


Important points - Sec 43B(h)

  • Only Micro and Medium Enterprises are covered in Income Tax Section 43B(h), turnover and investment criteria of micro and small enterprises is as under (ref. Notification No. 2119(E), dated 26-6-2020)

Micro Enterprises

Small Enterprises

Investment in Plant & Machinery or Equipment - upto 1 Crore

Investment in Plant & Machinery or Equipment - upto 10 Crore

Annual Turnover upto 5 crore

Annual Turnover upto 50 crore

  • As per para 2 of Office Memorandum: No. 5/2(2)/2020/E/P&G/POLICY dated 2-7-2021 issued by Central Government has clarified that “The Government has received various representations and it has been decided to include Retail and wholesale traders as MSMEs and they are allowed to be registered on Udyam Registration Portal. However, benefits to Retail and Wholesale trade MSMEs are to be restricted to Priority Sector Lending only.” Central Government’s office memorandum 1/4(1)/2021- P&G Policy, dated 01.09.2021, further clarifies that “the benefit to Retail and wholesale trade MSMEs are restricted up to priority sector landing only and other benefit, including provisions of delayed payment as per MSMED Act, 2006, are excluded. However, this restrictions in for the purpose of MSMED Act, 2006 only, Therefore, a clarity is expected from Government, whether Traders are excluded/included for the purpose of Section 43B(h) ?


Impact on businesses

The disallowance of expenses under the Income Tax Act can have a significant impact on businesses. It can lead to an increase in the taxable income of the company and result in higher tax liability. In addition, the disallowance of expenses can lead to a decrease in the profit margins of the company and impact its financial health.

To avoid the disallowance of expenses, businesses must ensure that they make timely payments to MSMEs. They must maintain records of all transactions with MSMEs, including the date of acceptance of goods or services and the date of payment. They must also ensure that they comply with the provisions of the Micro, Small and Medium Enterprises Development Act, 2006.

Conclusion

In conclusion, the disallowance of expenses under the Income Tax Act on account of non-payment to MSMEs is an important provision that aims to encourage prompt payments and support the growth of MSMEs. Businesses must ensure that they make timely payments to MSMEs to avoid the disallowance of expenses and maintain their financial health. By doing so, they can contribute to the growth of the economy and support the development of MSMEs.

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