Section 43B(h) : Applicability, Time Limit, Disclosure & External Confirmation for MSE Payments

Section 43B(h) : Applicability, Time Limit, Disclosure & External Confirmation for MSE Payments

Section 43B(h) of the Income Tax Act, introduced by the Finance Act 2023, emphasizes timely payments to Micro and Small Enterprises (MSEs) for goods and services. This provision comes into effect on April 1, 2024, and is applicable to payments governed by Section 15 of the MSMED Act, 2006. The primary goal is to ensure that payments to MSEs are cleared within the same financial year, regardless of whether the accounting method used is cash or accrual. Notably, Section 43B(h) is applicable only to manufacturers and service providers, excluding traders.

Applicability of Section 43B(h)

Starting from April 1, 2024, businesses are mandated to pay MSEs for their goods and services within the financial year, provided the payments are governed by Section 15 of the MSMED Act, 2006. Payments must be made by the end of the financial year in which the goods or services were accepted.

It’s important to note that Section 43B(h) only applies to payments made to MSEs classified as manufacturers or service providers. Traders who do not meet these criteria are not covered under this section.

Effective Date

Section 43B(h) becomes effective from FY 2023-2024 (Assessment Year 2024-2025), and it will enforce the timely settlement of dues to MSEs starting April 1, 2024.

Time Limit for Payments to MSEs under Section 43B(h)

  • No payment timeline specified in the contract: If the agreement between the buyer and the MSE does not specify a payment deadline, the buyer must settle the payment within 15 days from the date of acceptance of goods or services.

  • Payment timeline specified in the contract: If the contract specifies a payment deadline, the buyer must pay on or before the earlier of the two:

    • The agreed-upon payment date mentioned in the contract, or
    • 45 days from the date of acceptance of the goods or services.

Failure to meet these deadlines results in the accrual of compound interest at a rate three times the Reserve Bank of India’s bank rate, as outlined in Section 16 of the MSMED Act, 2006.

Consequences of Non-Payment and Interest Disallowance

Under Section 16 of the MSMED Act, if a buyer fails to pay an MSE within the prescribed timeline, they are liable to pay interest at a compounded rate with monthly rests. The interest rate is set at three times the RBI’s bank rate. This interest is payable regardless of any contrary agreement between the buyer and supplier.

Moreover, Section 23 of the MSMED Act explicitly disallows the deduction of this interest from the buyer’s taxable income under the Income Tax Act, 1961. Thus, the interest paid for delayed payments cannot be treated as a deductible expense while calculating taxable income.

Disclosure Requirements in Audited Financial Statements

In line with Section 22 of the MSMED Act, 2006, businesses must provide detailed disclosures in their audited financial statements regarding their transactions with MSEs. These disclosures include:

  • The principal amount and the interest due (to be separately disclosed) remaining unpaid at the end of the financial year.
  • The amount of interest paid to MSEs, along with the payments made beyond the stipulated time.
  • The interest due for delayed payments during the year (paid beyond the due date but without the inclusion of the statutory interest).
  • The interest accrued but unpaid at the year-end.
  • Future interest obligations payable in the succeeding years until the entire outstanding interest is cleared.

External Confirmation from Suppliers

To ensure compliance with Section 43B(h) and the MSMED Act, companies may need to obtain external confirmations from MSE suppliers. This can help verify the payment status and reconcile any outstanding dues, ensuring accurate disclosures and compliance with the provisions.

Section 43B(h) of the Income Tax Act, along with the provisions of the MSMED Act, serves as a critical legal framework to ensure the timely settlement of payments to Micro and Small Enterprises. By enforcing strict payment deadlines and requiring detailed disclosures in financial statements, this section aims to promote transparency and financial discipline among businesses. Companies should remain vigilant about compliance, particularly as the effective date approaches in FY 2023-2024.

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Startup vs MSME: What’s the Difference?

Startup vs MSME: What's the Difference?

The Government of India plays a pivotal role in promoting both Startups and MSMEs (Micro, Small, and Medium Enterprises), recognizing their importance in fostering entrepreneurship and economic growth. However, the distinction between the two can often be confusing for aspiring entrepreneurs. Understanding their legal definitions, purpose, and the support they receive can help budding businesses choose the right path.

1. What is a Startup?

A Startup is typically focused on developing innovative, repeatable, and scalable business models. The key characteristic of a startup is its aim to bring about technological advancements, improve productivity, and create employment opportunities.

Legal Definition of Startup (as per the Ministry of Commerce and Industry, Govt. of India):

  • Incorporation: The entity must be registered as a Private Limited Company (PLC), Partnership Firm, or Limited Liability Partnership (LLP).
  • Turnover: The entity’s turnover should be less than Rs. 100 crore in any of the previous financial years.
  • Age: An entity is recognized as a startup for up to 10 years from the date of incorporation.
  • Purpose: The startup must focus on innovation, improvement of products, services, or processes with the potential to generate employment or wealth. Any entity created by splitting or restructuring an existing business will not be considered a startup.

Startups are known for their disruptive ideas—solutions that improve how industries operate, influence consumer behavior, and even impact societal trends.

2. What is an MSME?

On the other hand, an MSME is more traditional in nature, focusing on providing known products or services to local markets. MSMEs are usually independently owned and operated businesses that prioritize profitability and stability over rapid scaling.

MSME Classifications:

  • MSMEs in India are categorized into two types:

    • Manufacturing Enterprises: These are involved in producing goods or products. The investment in plant and machinery ranges between Rs. 0 to Rs. 10 crore.
    • Service Enterprises: These are engaged in providing services. The investment in equipment ranges between Rs. 0 to Rs. 5 crore.

Registration and Benefits for MSMEs:

To receive the benefits offered by the government, businesses need to register as an MSME. The Ministry of Commerce supports MSMEs by providing access to:

  • Skill development and training programs
  • Medium and long-term loans
  • Working capital loans
  • Seed loans and bridge loans

These benefits are aimed at nurturing smaller enterprises by offering financial assistance and support in building capacity, upgrading technology, and sustaining business growth.

Key Differences Between Startup and MSME

AspectStartupMSME
PurposeFocuses on innovation and scalable business modelsFocuses on providing known products/services to local markets
Growth PotentialHigh-risk, high-reward with fast scalabilitySteady growth with stable operations
Legal StructurePrivate Limited, LLP, or Partnership FirmVaries, but usually smaller independent ownership
Age LimitRecognized for up to 10 yearsNo specific time limit
Turnover LimitLess than Rs. 100 croreVaries based on investment (Rs. 0 to Rs. 10 crore)
Innovation FocusMust work towards innovation or improvementInnovation is not a primary requirement
Government SupportFocused on promoting innovation and scalabilityFocused on providing financial assistance and stability

How to Start and Get Recognition?

For Startups:

To be recognized as a startup by the Government of India:

  1. Incorporate your business as a Private Limited Company, LLP, or Partnership Firm.
  2. Ensure your annual turnover is below Rs. 100 crore.
  3. Register through the Startup India portal to gain access to benefits like tax exemptions, intellectual property services, and government funding opportunities.
  4. The startup must be focused on developing innovative solutions or improving existing ones.

For MSMEs:

  • MSMEs need to register through the Udyam Registration portal to get an official recognition.
  • MSMEs benefit from a wide range of schemes that help in acquiring long-term loans, working capital loans, and access to subsidies for technological upgrades.
  • Depending on the sector, MSMEs can also avail training, skill development, and advisory services provided by the government.

Securing Loans and Financial Assistance

For Startups:

Startups often rely on external funding sources such as:

    • Angel Investors and Venture Capitalists (VCs) who provide seed funding in exchange for equity.
    • Government Grants and incentives under schemes like Startup India Seed Fund Scheme.
    • Bank Loans: Startups may also seek loans through traditional banking channels or special startup-focused programs.

For MSMEs:

MSMEs have access to multiple financial assistance programs such as:

    • Bank Loans: MSMEs can apply for loans through banks under the MSME Credit Guarantee Scheme.
    • Subsidized Loans: The government provides subsidized interest rates on loans for MSMEs under various schemes.
    • Schemes like CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises) offer collateral-free loans for eligible MSMEs.

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Section 43B(h) of the Income Tax Act: A New Paradigm for MSME Payments

MSME Payments

Section 43B(h) of the Income Tax Act: A New Paradigm for MSME Payments

MSME Payments

The Finance Act 2023 has introduced Section 43B(h) to the Income Tax Act, aiming to address the persistent issue of working capital shortages in the Micro, Small, and Medium Enterprises (MSME) sector. This amendment mandates that any sum owed to Micro and Small Enterprises (MSEs) for goods supplied or services rendered can be deducted in the same fiscal year if paid within the deadline specified by the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. Effective from April 1, 2024, this provision applies to the assessment year 2024-25 and beyond.

Key Highlights of Section 43B(h)

Payment Timeframe and Deduction Criteria

The newly inserted clause (h) under Section 43B specifies that any sum payable to a Micro or Small Enterprise, if not paid within the time limits set by Section 15 of the MSMED Act, will only be deductible in the year of actual payment, regardless of the accounting method employed. The MSMED Act stipulates that payments must be made within 45 days if a written agreement exists or within 15 days if there is no written agreement.

MSME Classification Criteria

Micro and Small Enterprises are classified based on their investment and turnover:

  • Micro Enterprises: Investment in plant and machinery not exceeding ₹1 crore and turnover not exceeding ₹5 crores.
  • Small Enterprises: Investment in plant and machinery not exceeding ₹10 crores and turnover not exceeding ₹50 crores.

Applicability and Exclusions

This clause applies when a business procures goods or services from an MSE registered under the MSMED Act. Notably, it is not necessary for the buyer to be registered under the MSMED Act. However, wholesale and retail traders are excluded from this provision, as they are only entitled to Udyam registration for Priority Sector Lending benefits, not for the benefits under Section 43B(h).

Effective Date and Compliance

Section 43B(h) will come into effect from April 1, 2024, and will be applicable from the assessment year 2024-25. Businesses must adhere to the 45-day payment rule specified by the MSMED Act to claim deductions in the same fiscal year. Failure to comply will result in deductions being deferred to the year of actual payment.

Penalties for Late Payment

Late payments to MSMEs attract a penalty in the form of compound interest, calculated at three times the bank rate notified by the Reserve Bank of India (RBI). This interest is payable from the day following the agreed payment period or from 15 days after the acceptance of goods or services, whichever is earlier. Importantly, this interest is not deductible as an expense under the Income Tax Act.

Benefits of Section 43B(h)

For MSMEs:

  1. Smooth Payment Cycle: Ensures timely cash flow, crucial for MSME sustainability and growth.
  2. Better Bargaining Power: MSMEs can confidently negotiate payment terms, assured of timely payments.
  3. Reduced Disputes: Minimizes potential disputes and legal issues arising from outstanding dues.

For Larger Enterprises:

  1. Tax Planning: Timely payments enable larger enterprises to claim deductions within the same year, reducing tax liabilities.
  2. Compliance and Transparency: Promotes transparent financial practices and adherence to regulations.
  3. Robust MSME Ecosystem: Encourages a healthy MSME sector, benefiting larger enterprises through a reliable supply chain.

Practical Scenarios

  • Invoices from 01.04.2023 to 15.02.2024: If paid by 31.03.2024, expenses are allowable in FY 2023-24.
  • Invoices from 16.02.2024 to 31.03.2024: If paid within 45 days (assuming a written agreement), expenses are allowable in FY 2023-24.
  • Invoices paid after the due date: If payments for March 2024 invoices are made in June 2024, expenses are allowable in FY 2024-25.

How to Verify MSME Registration

To verify MSME registration and the type of enterprise, visit the MSME Portal and use the registration number. Verification can be done through the following link: MSME Registration Verification.

In conclusion, Section 43B(h) is a significant step towards ensuring prompt payments to MSMEs, fostering a healthier business environment, and enhancing the sustainability and growth of the MSME sector. By complying with these regulations, businesses can benefit from smoother operations, better tax planning, and a robust supply chain.

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