In line with the Prime Minister’s vision of ‘extending maximum support to Micro, Small and Medium Enterprises (‘MSMEs’)’, the central government vide the Finance Act, 2023 introduced Section 43B(h) in the Income-tax Act, 1961 (‘IT Act’). Introduced as a Socio-Economic Welfare Measure, the provision mainly ensures that timely payments are made to micro and small enterprises.
In essence, the provision provides that payments made to micro and/or small enterprises shall be allowed as a deduction only if the payments are made within the time mandated under Section 15 of the Micro, Small, and Medium Enterprise Development Act, 2006 (‘MSME Act’). In all other cases, the payments shall be allowed as a deduction only in the financial year when the payment is made to micro and/or small enterprise.
Despite the well-placed intent behind introducing the aforesaid provision, the cross-linkage of the IT Act with the MSME Act may cause certain ambiguities specifically concerning the deduction of the provision of expenses, calculating the time limit under the MSME Act, etc. This article aims to highlight some of these ambiguities and associated practical hardships that a businessman would face going forward.
ICDS v. MSME Act – Interplay with the provision of expense
Income Computation and Disclosure Standards (‘ICDS’) X relating to provisions, contingent liabilities, and contingent assets provide guidance on the computation of income chargeable under the head ‘Profits and gains of business or profession’ and ‘Income from other sources’.
Amongst other things, ICDS X[1] defines the term ‘provision’ to mean a liability that can be measured using a substantial degree of estimation. Further, the term ‘liability’ is defined to mean a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources.
In view of the aforesaid definition, a taxpayer in certain scenarios can recognize a provision of expense and claim a corresponding deduction even in the absence of actual completion of services. However, a challenge would arise in cases where the taxpayer (i.e., service recipient) has booked a provision of expense in relation to services rendered by micro or small enterprises registered under the MSME Act despite actual completion of rendition of service. In such a scenario, a question would arise as to whether the provisions of Section 43B(h) of the IT Act read with Section 15 of the MSME Act will be attracted in the hands of the service recipient.
To appreciate the aforesaid query, it is pertinent to understand the scope and meaning of Section 15 of the MSME Act. Section 15 of the MSME Act provides that a buyer must make payment against receipt of goods or services to the MSME vendor in the following manner:
In cases where there is a written agreement: The payment shall be made on or before the date agreed upon between the parties. However, the same cannot be more than 45 days from the actual delivery of goods or rendering of services.
In cases where there is no written agreement: The payment must be made within 15 days of the actual delivery of goods or rendering of services.
In view of the aforesaid provision, one possible view could be that the timeline provided in Section 15 of the MSME Act will be triggered only upon completion of the delivery of goods or the rendering of service and the same has no co-relation with the date of creation of provision of expenses. This statement can further be explained with the help of the following illustration.
Illustration
Let’s say Company A has entered into an annual maintenance contract with Company B (i.e., a small enterprise under the MSME Act) for a period of one year (i.e., January 2024 to December 2024). Pursuant to the contract, Company A is required to pay the agreed consideration at the end of the contract period. However, on 31 March 2024, Company A booked a provision for maintenance expense in relation to services received from January 2024 to March 2024 as per ICDS X and claimed the corresponding deduction during FY 2023-24.
In this regard, the primary question would be whether the deduction of provision of expense would be allowed or the same will be subject to the rigors of Section 43B(h) of the IT Act?
In the aforesaid scenario, Company A (i.e., service recipient) may argue that the provisions of Section 43B(h) of the IT Act may not apply to disallow the expense as the timeline provided in Section 15 of the MSME Act will not stand breached as on 31st March. This is because the timeline provided in Section 15 of the MSME Act will initiate from the completion of services (i.e., 45 days from 31st December 2023). Even at the time of filing return of income, the compliance to timelines provided in section 15 of MSMED Act would not be ascertainable. In such cases, if Company A does not make payment within the prescribed time (i.e. 45 days from December 2024), the tax officer may seek to disallow the provision expense at the time of assessment.
Other practical issues
In addition to the above, taxpayers may have to evaluate the application of Section 43B(h) of the IT Act in the case of composite contracts, continuing services, and services provided by del credere agent. Some of these practical issues are explained with the help of an illustration in the subsequent paragraphs.
Issue 1: Applicability of the provisions of Section 43B(h) in case of composite contract
For instance, let’s say that Company A engages Company B (i.e., a small enterprise under the MSME Act) for the purchase and installation of a lift at its office premises on 1st December 2023. As per the contractual arrangement between the parties, Company A is liable to pay a consolidated amount of consideration upon the completion of the project (i.e., on 1st April 2024). Further, the parties understand that the timeline for various activities is as follows:
Date of supplying lift by Company B: 15 December 2023
Date of installation of lift by Company B: 1 April 2024.
In the aforesaid factual background, a question would arise as to whether the time limit prescribed in Section 15 of the MSME Act will initiate from the date of supplying the lift (i.e., the predominant activity) or from the date on which the installation was completed.
In the present scenario, Company A may argue that the time limit of 45 days will begin from the day when the installation services are completed. This is because the activities of supplying lift and installation were part of a single composite contract.
Consequently, Company A may argue that if it has made a payment on or before the aforesaid timeline, it will be entitled to claim a deduction for the payment on an accrual basis.
Issue 2: Applicability of the provisions of Section 43B(h) involving agent registered as per MSME Act
Ambiguity may also arise in cases where a taxpayer is required to remit a commission fee to a del credere agent (i.e., a small enterprise under the MSME Act) and there is a time lag between the date of sale and the date of collections of sale proceeds. In such a case, a question could arise as to whether the timeline under Section 15 of the MSME Act will initiate from the date of sale or the date of collection.
In the present scenario, taxpayers can take a view that the time limit prescribed under Section 15 of the MSME Act will initiate from the date of collection of sale proceeds. This is because one of the primary responsibilities of the del credere agent is the collection of sales proceeds, and the services of the del credere agent cannot be considered to be completed till the date of collection.
Conclusion
The provisions of Section 15 of the MSME Act and 43B(h) of the IT Act ensure timely payments to MSMEs, with an intent to reduce the credit period and consequent increase in working capital requirements for MSMEs. However, clarity is required in these provisions with respect to, inter alia, composite contracts, continuing services, etc. Otherwise, ambiguity surrounding such stringent provisions may make buyers wary of dealing with MSMEs, which is counterproductive to the intention of these provisions.
[The authors are Partner, Principal Associate and Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys, New Delhi]
[1] Notification No. 87/2016, dated 29 September 2016.
