Closing of Financial Year 2024-25: Compliance with Section 43B(h) for MSME payments, Check your creditors now

With the financial year 2024-25 nearing its closure, businesses must ensure compliance with various tax regulations to avoid disallowances and penalties. A significant change, effective from April 1, 2023 (FY 2023-24 & AY 2024-25), is the introduction of Section 43B(h) in the Income Tax Act. This amendment emphasizes timely payments to Micro and Small Enterprises (MSMEs), reinforcing their financial stability and ensuring liquidity in the sector.

Despite expectations of a deadline extension for this clause, the government has not provided any relief as of now. Hence, businesses must comply with this provision by March 31, 2025, to avoid adverse tax implications.

Understanding Section 43B(h)

Section 43B of the Income Tax Act allows specific deductions only on an actual payment basis, rather than accrual. While other payments under Section 43B enjoy the benefit of deduction if paid before the due date of filing the return under Section 139(1), payments to MSMEs do not qualify for this relaxation.

Key Provision of Section 43B(h):

• Any sum payable to a Micro or Small Enterprise beyond the time limit prescribed under Section 15 of the MSMED Act, 2006, shall be allowed as a deduction only in the year of actual payment.
• The buyer’s registration under the MSMED Act is not mandatory; only the seller’s MSME registration determines applicability.
• Medium enterprises are excluded from this provision.

Definition of Micro & Small Enterprises

The MSME classification is based on investment in plant & machinery/equipment and annual turnover:

Payment Timelines under MSMED Act, 2006

As per Section 15 of the MSMED Act, 2006:

• If there is no written agreement, payment must be made within 15 days.
• If a written agreement exists, payment must be made within 45 days.

Failure to pay within these timelines results in ineligibility for deduction until the actual payment year.

Impact on Taxable Income

• Payments made beyond the permissible period become part of the assessee’s taxable income for that financial year.
• Deduction for such payments is only allowed in the year when the payment is actually made.
• Late payments attract compound interest at three times the RBI-notified bank interest rate.

Interest Expense and Disallowance under Section 37

• Interest on delayed payments to MSMEs is considered penal interest, disallowed under Section 37.
• Compound interest on delayed payments must be paid monthly, even if the supplier does not demand it.

Practical Illustrations

To clarify the impact of this amendment, let’s examine a few scenarios:

Key Takeaways for Businesses

1. Ensure timely payments to Micro & Small Enterprises before the financial year ends to claim deductions in FY 2024-25.
2. Review supplier MSME registration status to ascertain if Section 43B(h) applies.
3. Reconcile outstanding payments to MSMEs and prioritize clearing them before March 31, 2025.
4. Avoid penal interest by making payments within the prescribed timeframe.
5. Update accounting software and internal controls to flag payments nearing due dates.

Conclusion

With the closing of FY 2024-25, compliance with Section 43B(h) is crucial for businesses engaging with MSMEs. Since no relaxation has been granted by the government, businesses must clear outstanding MSME dues before March 31, 2025, to avoid disallowances and tax burdens. Timely action will ensure smooth compliance and prevent unnecessary financial strain.

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