MSME 45 Days Payment Rule: Amendments to Income Tax Act on cards related to tax treatment of MSME Dues

A reform made to the Income Tax Act last year to enable small businesses to obtain timely payments may have had the unintended consequence of discouraging buyers of their goods and services entirely. According to two people familiar with government discussions, the Centre may change the Act again in the full FY25 budget in July.

What is unknown is the exact change that could be implemented. According to one of the two individuals cited above, “It is very likely that clause (h) of section 43B may be dropped.” The second person stated that it was too early to discuss specific changes that may be introduced. Both individuals spoke on the condition of anonymity.

Clause (h) was inserted into Section 43B of the Income Tax Act in order to solve liquidity concerns faced by MSMEs (micro, small, and medium enterprises). The section, which was included in the Finance Act 2023, states that payments to small businesses that are delayed for more than a defined period can be claimed as an expense (deduction from taxable income) only in the financial year in which the payments are made, not the year in which the liability to pay arose.

“However, there is concern among small businesses that as an unintended consequence, large procurers would avoid buying from small firms to avoid this provision in the law,” the first person in mentioned above said.

“This concern would be addressed in the Finance Bill to be presented as part of the full-year budget for FY25.” he further added.

According to a tax expert, the Income Tax Act should only be utilized selectively for broader social objectives that are addressed by other laws. He went on to explain how the provision affects customers of MSME goods and services. A company that misses a payment deadline experiences an increase in its tax liability during the financial year as a result of the disapproval of the benefit of the deduction for the payment liability accrued.

He added, “If the deduction is granted in a subsequent year of payment, the tax burden accrued earlier owing to late payment is not eliminated. Besides, it could reduce profits in the year in which the payment is paid. And if income turns out to be negative, in some situations, it could take years for the corporation to offset it against earnings in subsequent years.”

The Micro, Small, and Medium Enterprises Development (MSMED) Act defines timely payment as payment made within 15 days, or 45 days if ensured by a signed contract. However, many industries have a longer payment cycle—three to six months.

The second source quoted above stated that Finance Minister Nirmala Sitharaman is aware of the issues highlighted by small firms. In response to a question, Sitharaman told a gathering in Jaipur on April 16 that the finance ministry had conducted a thorough review in 2022-23 to ensure that all central public sector undertakings cleared payments to MSMEs and then maintained the 45-day payment cycle, but the Union finance ministry was unable to determine dues to MSMEs from state PSUs or the private sector, so suggestions were sought.

The minister stated that MSMEs themselves informed the government that enterprises do not pay within 45 days, or even during the financial year, but instead reap financial advantages by claiming it as expenditure. “MSMEs themselves gave that thought to us,” Sitharaman remarked, referring to how enterprises shamelessly violate the timetable set by the MSMED Act.

The FM stated that the Income Tax Amendment of 2023 was solely intended to ensure that the benefit is taken in the year in which payment is made. Sitharaman also noted that small businesses are now claiming that big firms are avoiding buying from small enterprises, with one group even requesting an ordinance after the Lok Sabha was prorogued ahead of national elections.

The minister did not say what the government would do in the full budget, but the second person quoted above said the intent of the Income Tax provision, as highlighted by Sitharaman, was to encourage timely payments to small businesses, and that any unintended consequences would be addressed in the next Finance Bill, but it was too early to discuss specific amendments that might be made.

Businesses that delay some payments, such as taxes and loan interest payments, may still be eligible for a deduction if they make the payment after the end of the financial year but before filing their tax returns. This flexibility is likewise not accessible for late payments to small firms.

Source