MSME Changes as per Income Tax Act,1961 and MSMED Act, 2006

Section 43B(h) of the Income Tax Act, effective from AY 2024-25, disallows expense deductions for delayed payments to Micro and Small Enterprises (MSEs). Payments must be made within 15 days (if no written agreement) or 45 days (if agreed upon) to avoid disallowance. MSME classification is based on Udyam Registration, with new limits applicable from April 1, 2025. Traders registered as MSMEs are not covered. Interest on late payments under the MSMED Act is three times the RBI rate and is not deductible. Businesses must disclose outstanding MSME dues in financial statements and Form 3CD. Ensuring timely payments and accurate reporting helps avoid penalties and tax liabilities.

1. Applicability of Section 43B(h) – Effective from AY 2024-25

The Finance Act, 2023 introduced Clause (h) under Section 43B of the Income Tax Act, which disallows deduction for payments due to Micro and Small Enterprises (MSEs) if not made within the prescribed time under Section 15 of the MSMED Act, 2006.

• The provision is applicable from April 1, 2024, i.e., for Assessment Year 2024-25 and onwards.
• The due date for payment is:
  • 15 days from the date of acceptance of goods/services if there is no written agreement.
  • Up to 45 days if a written agreement exists between the buyer and the MSME supplier.
• If the payment is not made within the above timelines, the amount is disallowed as an expense in that financial year and can be claimed as a deduction only in the year of actual payment.

2. MSME Classification & Registration

To determine whether Section 43B(h) applies, the supplier must be a Micro or Small Enterprise registered under Udyam Registration.

(A) Classification of MSMEs (As per MSMED Act, 2006)

Based on investment and turnover limits: Existing limit

The Changes in the limit is applicable from 01st April 2025.

Comparison of MSME Classification: Old vs. New Limits

• Obtain Udyam Registration Certificate to confirm MSME status.
• Check GST Registration to verify whether the entity is a trader or a service provider/manufacturer.
• Traders registered under MSME are not eligible for the benefits under MSMED Act, and therefore, payments to them will not attract disallowance under Section 43B(h).

3. Disallowance Under Section 43B(h) – Key Considerations

The disallowance will be triggered only if:

1. The supplier is a Micro or Small Enterprise (as per Udyam registration).

2. The payment remains outstanding beyond the prescribed time limit (15/45 days).

3. The amount was debited to the Profit & Loss account in the current financial year (FY 2023-24, i.e., before 31.03.2024).

Points to Remember:

♦ Purchases from MSMEs that remain unsold at the year-end (closing stock) will also attract Section 43B(h) disallowance if payment is delayed.

♦ Payments made after 31st March but within the MSME Act time limits will not be disallowed.

♦ MSME registration is prospective—bills issued before MSME registration date will not attract interest under Section 16 or disallowance under 43B(h).

4. Interest Payable Under Section 16 of MSMED Act

• If the buyer fails to make timely payment, interest is payable on the outstanding amount.
• Rate of Interest: Three times the RBI-notified bank rate, compounded monthly.
• Even if the supplier waives the interest, it remains payable under law.
• Interest paid or payable under Section 16 is not deductible under Income Tax (Section 23, MSMED Act).

5. Disclosures & Compliance Requirements

(A) Notes to Financial Statements (As per Section 22, MSMED Act)

Entities must disclose:

1. The principal amount and interest due (separately) remaining unpaid at year-end.

2. Interest paid during the year on delayed payments.

3. Interest accrued but not yet paid.

4. Interest due for future years.

5. The amount of further interest payable, if applicable.

(B) Form 3CD (Tax Audit Report)

• Clause 22 of Form 3CD requires reporting of outstanding dues to MSMEs.
• The amount disallowed under Section 43B(h) should be disclosed.

6. Key Differences Between MSMED Act & Section 43B(h)

7. Practical Implications for Businesses

• Verify MSME status before recording purchases – check Udyam Registration and GST registration.
• Ensure payments to MSEs are made within 15/45 days to avoid disallowance under 43B(h).
• Maintain proper records of MSME dues for reporting in financial statements and tax audit report (Form 3CD).
• Interest on delayed payments should be recognized and disclosed properly.

8. Summary & Final Takeaways

• Section 43B(h) applies from AY 2024-25, disallowing deductions for delayed payments to Micro & Small Enterprises.
• Traders registered under MSME are not covered—only payments to service providers and manufacturers are affected.
• Ensure timely payments (within 15/45 days) to avoid disallowance.
• Interest on late payments (3X RBI rate) is mandatory under MSMED Act and is not tax-deductible.
• Proper disclosures must be made in financial statements and Form 3CD (Tax Audit Report).