Budget 2024: Repercussions of delayed payments to MSMEs – amendments are much needed

MUMBAI: Micro and small enterprises have made a host of representations to the Finance Ministry for an amendment to a provision (popularly known as the

45 day payment rule

) that was aimed at protecting them. This however, as reported in the media, led to a decline in sales for several such entities as buyers looked elsewhere to source their supplies.
Section 43B provides for allowing certain expenses to be deducted from income only on actual payment made during a particular financial year.

The proviso to this section however relaxes the time period in relation to various payments to provide that no disallowance will be made in a case where the payment is made on or before the due date of filing the Return of Income as specified u/s. 139(1) of the Act.
The Finance Act, 2023 inserted clause (h) which provides that any sum payable by a taxpayer (say a business entity) to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2000, shall be allowed only on actual payment. The time limit is one agreed between the buyer and seller, but it cannot be more than 45 days from the date of supply.
Sandeep Choudhary, partner at Yoshita & Co, a firm of chartered accountants points out, “The proviso to section 15 of the MSMED Act, restricts the credit period to a maximum of 45 days, even if the parties want to agree to a longer period. These are matters best decided by the contracting parties.”

Thus, in order to be treated as a business deduction, payments to micro and small enterprises have to be made by the buyer within 45 days. The extended time period for making the payment on or before the date of filing the Income-tax return, to ensure it is not a disallowable expenditure, is not available to payments made under clause (h) – aka to payments made to micro and small enterprises.

Challenges that have arisen:

The Chamber of Tax Consultants (CTC) in their pre-budget memorandum point out the challenges that have arisen. If the payment is not so made within the period of the 45 days, the buyer suffers a disallowance. The payment made within the same financial year, however, does not suffer the disallowance since the deduction gets allowed on account of the payment.

CTC points out that many buyers have stopped doing business with such enterprises as delay in payment is likely to result in disallowance which will ultimately result in higher tax liability for the buyer. Many of the micro and small enterprises are also feeling it is worth to cancel their registration under the MSMED Act with the purpose of not losing the business. They are happy to get a delayed payment as compared to loss of business which might be fatal for their survival.
In fact, micro and small enterprises are protected by another clause. Where the payment to such enterprises are delayed beyond the time specified, section 16 of the MSMED Act makes it mandatory for the buyer to pay compound interest with monthly rest to the supplier at the rate which is three times the bank rate as notified by the Reserve Bank of India. The payment of such interest is not an allowable expense in the hands of the buyer, in accordance with the provisions of section 23 of the MSMED Act
“This is a sufficient deterrent against the buyer who delays the payment to the micro and small enterprises. Accordingly, it is felt that insertion of section 43B(h) results in more difficulties rather than solving the difficulties of such entities,” states CTC.
Bhadresh Doshi, chartered accountant states, “The new provision disallowing the whole of the expenditure if the corresponding liability has not been paid to the micro or small enterprise within the permitted time is hitting all the businesses hard. It affects the cash flow badly because the tax needs to be paid on such unpaid liability in addition to that liability itself. The tax payment gets reversed only in the subsequent year in which the micro or small enterprise has been paid off. Although such provision is needed to protect the interest of small businesses, it cannot be made too harsh to wipe out their existence by making them irrelevant for others to do business with them. Thus, this provision needs to be rationalised striking a balance between the interest of the micro or small enterprise on one hand and the businesses at large on the other hand.”

Suggestions:

Choudhary advocates abolition of clause (h). According to him, “Failure to pay within the contractual period has to be dealt with by the contract enforcement system. To help micro and small businesses with timely payments, section 18 of the MSME Development Act, 2006 provides for a Facilitation Council. The Govt has set up a MSME Samadhan Portal: any micro or small business can apply online in case of delay in payment. We need to strengthen such platforms, as well as courts and arbitration systems, to improve contract enforcement. Tax laws are not well-suited to achieve these objectives.”
Doshi adds, “At least an extended time period till the due date for filing of the I-T return needs to be provided here as it is available in case of other dues like taxes payable to the government, interest payable to banks etc. Else it would be an illogical proposition whereunder the

delayed payments

during the financial year itself does not have repercussions but only the year-end liability will face the disallowance if not paid within permitted timeline.”
He adds, “Further, micro or small enterprise itself has not been left out from the rigours of this provision. If cash flow of such an entity has been affected due to its payments being delayed or for any other reason, then it is quite possible that it might result in a consequential delay in discharging its own liability. In such a case, if any of the suppliers of such an entity is once again micro or small enterprise, then it will also get disallowed under this provision. Meaning thereby, delayed payments by one MSE to another MSE is also subject to disallowance under this provision irrespective of the reasons. At least this position needs to be rectified through a suitable amendment.”
CTC has provided various alternate suggestions:
-Clause (h) of section 43B should be omitted
-If this is not acceptable, then proviso to section 43B which enables payment to be made till the date of filing the I-T return under section 139(1) without the repercussion of disallowability should be extended to payments made to micro and small enterprises
-As a last alternative, clause (h) may be suitably amended to provide that the disallowance will be made in case of failure to make the payment to micro or small enterprise beyond the time limit as agreed between the supplier and the buyer.