Disallowance under Section 43B(h) of Income Tax Act: Non-Payment to Suppliers within 15 or 45 days under MSMED Act

Generally expenses are allowed based on accounting method followed by the Assessee. If you follow Mercantile method of Accounting, you will be allowed expenses on accrual basis. If you follow Cash accounting, you will be allowed to claim expenses on actual payment basis. However, Income Tax Act has carved out an exception here in respect of certain expenses. 

Section 43B lists out certain expenses which are allowed only on actual payment basis. Finance Act 2023 inserted a new clause (h) in Section 43B which states that if any sum is payable by the assessee to a micro or small enterprise and if it is not paid within the time limit specified in Section 15 of the MSMED Act, 2006, the assessee cannot claim it as an expense until the said sum is actually paid. Such disallowed amount will be allowed to claim as expenditure in the year of actual payment. This provision is applicable w.e.f. FY 2023-24 (AY 2024-25)

Let us first understand the criteria for Micro, Small & Medium Enterprises as per MSMED Act:

Classification(#)	Investment($) in Plant and Machinery or Equipment	Turnover(^)
Micro	<= Rs. 1 Crore	<= Rs. 5 Crore
Small	<= Rs. 10 Crore	<= Rs. 50 Crore
Medium	<= Rs. 50 Crore	<= Rs. 250 Crore

(#) A composite criterion for classification of Micro, Small & Medium enterprises shall apply which means if an enterprise crosses the ceiling limits specified for its present category in either of the two criteria of investment or turnover, it will cease to exist in that  category and be placed in the next higher category but no enterprise shall be placed in the lower category unless it goes below the ceiling limits specified for its present category in both the criteria of investment as well as turnover.

($) Investment in Plant and Machine or Equipment for the purpose of MSME Classification does not include Land, Building, Furniture, Fixture or Intangible Assets. Such investment shall be valued on WDV basis, i.e. after deducting accumulated depreciation from the original cost of plant and machinery or equipment.

(^) Turnover for the purpose of MSME Classification does not include Exports Turnover.

Some important points to consider in understanding this provision are as follows:

1. Provision applicable only where your supplier is a 
• Micro or Small Enterprise as defined in MSMED Act,
• A Manufacturer or a Service Provider and
• Registered on UDYAM Portal under MSMED Act
2. Provision not applicable if your supplier is a 
• Medium Enterprise as defined in MSMED Act or
• A Trader (Wholesaler or Retailer) or
• Not registered on UDYAM Portal under MSMED Act
3. MSME Status of the buyer of goods or service is not important
4. Section 15 of MSMED Act stipulates that if goods or services are supplied by a MSME Supplier, the buyer is obligated to make payment within:
• agreed payment period^(*) from the date of acceptance/deemed acceptance of goods/service or
• 15 days being the stipulated payment period where no agreement on payment period exists
  * Notably, the agreed payment period cannot exceed 45 days from the date of acceptance / deemed acceptance. This provision is designed to protect the interests of micro, small, and medium enterprises by ensuring timely payments for their goods and services.
5. Interest @ 3 times the Bank Rate is applicable in case of delayed payment to the supplier registered under MSMED Act
6. Payment of such interest on delayed payment to supplier registered under MSMED Act will not be allowed as an expenditure under Income Tax Act
7. Section 43B(h) may not apply to assessees opting for presumptive taxation under Sections 44AD, 44ADA, 44AE, 44BBB and 115VA as these sections start with a non-obstante clause i.e. "Notwithstanding anything to the contrary contained in Sections 28 to 43C" 
8. Section 43B(h) does not make any distinction between revenue expenditure and capital expenditure as it says "any sum payable". Hence in my opinion, the said disallowance will be attracted even in case of purchase of fixed assets. But since fixed assets are capitalized and not claimed as an expense in profit & loss account, it should not have any impact on the income of the assessee. With regard to the claim of depreciation, considering the decision in Lemnisk (P.) Ltd. v. Dy. CIT [2022] 141 taxmann.com 195 (Bangalore – Trib.), depreciation should not be disallowed
9. Section 43B(h) is not applicable while calculating MAT u/s 115JB
10. In case where partial payment is outstanding beyond due date, the disallowance may be limited to the outstanding amount only
11. In case where the cheque is handed over to the supplier on or before the due date, but it was not encashed by them beyond due date, in my opinion, such payment should be regarded as made on the date the cheque is handed over to the supplier, provided the cheque does not bounce subsequently and sufficient balance was maintained in the account on the day the cheque was handed over

Other points with respect to due date calculation for the purpose of Section 15 of MSMED Act:

1. Date of delivery of goods or service v/s Date of Invoice: In case where date of delivery of goods or service falls later than the date of invoice, date of delivery will be considered as date of acceptance.
2. Where after date of delivery, the buyer has raised any objection with respect to the goods or service supplied, the final date of acceptance will be the date when supplier resolves the objection raised by buyer.
3. Date of deemed acceptance is the date of delivery of goods or service where the buyer does not raise any objection within 15 days of the date of delivery of goods or service.
4. Date of acceptance or deemed acceptance is to be included while calculating the agreed payment period or stipulated payment period. 
• EXAMPLE: Suppose date of acceptance is 01-03-2024 and the agreed payment period is 40 days. The due date of payment will be 09-04-2024 and if payment is done on or after 10-04-2024, the said expenditure will be disallowed for FY 2023-24 and allowed in the year of actual payment i.e. FY 2024-25.

Let us now understand this provision with some practical examples:

EXAMPLE_A: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a manufacturer of goods and a registered Micro Enterprise as per MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-03-2024. The agreed payment period in invoice is 40 days. Now the Devil Industries pays the said invoice on 12-04-2024 i.e. after the agreed payment period. 

SOLUTION_A: The said amount of purchase  worth Rs. 1,00,000/- will be disallowed in the Income Tax Return of Devil Industries for FY 2023-24 (AY 2024-25). This will increase their profit for the year by Rs. 1,00,000/- and they will have to pay tax on that amount in FY 2023-24 return. However Devil Industries will be allowed to claim the said amount of Rs. 1,00,000/- as expense in the year of actual payment i.e. FY 2024-25 (AY 2025-26). 

EXAMPLE_B: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a manufacturer of goods and a registered Micro Enterprise as per MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-03-2024. There is no agreement with respect to payment period of the invoice. Now the Devil Industries pays the said invoice on 05-04-2024.

SOLUTION_B: Where no payment period is agreed between the buyer and supplier, the payment is to be made within 15 days of the date of acceptance / deemed acceptance. Devil Industries delayed the payment for more than 15 days in this case, hence the said amount of purchase  worth Rs. 1,00,000/- will be disallowed in the Income Tax Return of Devil Industries for FY 2023-24 (AY 2024-25). This will increase their profit for the year by Rs. 1,00,000/- and they will have to pay tax on that amount in FY 2023-24 return. However Devil Industries will be allowed to claim the said amount of Rs. 1,00,000/- as expense in the year of actual payment i.e. FY 2024-25 (AY 2025-26). 

EXAMPLE_C: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a manufacturer of goods and a registered Micro Enterprise as per MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-03-2024. The agreed payment period in invoice is 60 days. Now the Devil Industries pays the said invoice on 25-04-2024.

SOLUTION_C: As per Section 15 of MSMED Act, the agreed payment period cannot exceed 45 days, hence even though in this case the agreed payment period exceeds 45 days, the payment has to be made within 45 days of acceptance of goods/service. In this example the buyer makes payment within the agreed payment period of 60 days but beyond stipulated payment period of 45 days, hence the expense worth Rs. 1,00,000/- will be disallowed in the FY 2023-24 (AY 2024-25) return. However Devil Industries will be allowed to claim the said amount of Rs. 1,00,000/- as expense in the year of actual payment i.e. FY 2024-25 (AY 2025-26).

EXAMPLE_D: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Badelal, a manufacturer of goods and a registered Medium Enterprise as per MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-03-2024. The agreed payment period in invoice is 30 days. Now the Devil Industries pays the said invoice on 25-04-2024.

SOLUTION_D: In this example, as the supplier Mr. Badelal is a Medium Enterprise as per MSMED Act, no disallowance as per Section 43B(h) will be attracted, however Mr. Badelal can claim interest on delayed payment as per MSMED Act from Devil Industries as they have not made the payment within agreed payment period of 30 days. 

EXAMPLE_E: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a registered Micro Enterprise as per MSMED Act. However Mr. Chotelal is a Trader and not a manufacturer of goods. The said goods are delivered to and accepted by Devil Industries on 01-03-2024. The agreed payment period in invoice is 30 days. Now the Devil Industries pays the said invoice on 25-04-2024.

SOLUTION_E: In this example, though the supplier Mr. Chotelal is a registered Micro Enterprise as per MSMED Act, no disallowance as per Section 43B(h) will be attracted because Mr. Chotelal is a Trader and not manufacturer or service provider. However Mr. Chotelal can claim interest on delayed payment as per MSMED Act from Devil Industries as they have not made the payment within agreed payment period of 30 days. 

EXAMPLE_F: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a manufacturer of goods and a registered Micro Enterprise as per MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-04-2023. The agreed payment period in invoice is 45 days. Now the Devil Industries pays the said invoice on 31-03-2024 i.e. after the agreed payment period. 

SOLUTION_F: In this example, though Devil Industries has made the payment of invoice after the agreed payment period of 45 Days which is also the maximum stipulated payment period as per MSMED Act, no disallowance under section 43B(h) will be attracted as the payment was made in the FY 2023-24 and hence the same can be claimed as expense on actual payment basis. However Mr. Chotelal can claim interest on delayed payment as per MSMED Act from Devil Industries as they have not made the payment within agreed payment period of 45 days. 

EXAMPLE_G: Suppose Devil Industries buys some goods worth Rs. 1,00,000/- from Mr. Chotelal, a manufacturer of goods and a Micro Enterprise as per MSMED Act but not registered under MSMED Act. The said goods are delivered to and accepted by Devil Industries on 01-04-2023. The agreed payment period in invoice is 45 days. Now the Devil Industries pays the said invoice on 30-04-2024 i.e. after the agreed payment period. 

SOLUTION_G: In this example, though Devil Industries has delayed the payment however no disallowance under section 43B(h) will be attracted. Although Mr. Chotelal is a manufacturer of goods, a micro enterprise as per definition under MSMED Act, but because he is not registered under MSMED Act on the date of acceptance of invoice, the said delayed payment will not be disallowed in the hands of Devil Industries under section 43B(h) of Income Tax Act. Here Mr. Chotelal cannot even claim interest for delayed payment under MSMED Act as he was not registered under MSMED act on date of acceptance of invoice.