Ensuring Timely payment to Micro & Small Enterprises through Income Tax Law: Pros & Cons
MSME are growth engines of our economy. Micro, Small and Medium Enterprises Development Act (MSMED) was enacted to take care of the MSME by creating an ecosystem of timely payment. As per section 15 of the MSMED Act, payment to Micro and Small enterprises is to be made before the Appointed Day. The Appointed Day is 15 days (which can be up to 45 days in case there is an agreement in writing) from the day of actual delivery of goods or the rendering of services.
Moving forward now, the Income Tax Act is also incorporating a provision to promote the timely payment to MSME. Though the intent is appreciable, the side effects of the provision could be more upsetting & cascading. Let us know about it.
Proposal for MSME in the Finance Bill – 2023:
At present, Section 43B of the Income Tax Act provides for deduction of certain expenditure only on payment basis i.e., the deduction is available only if the amount is paid within the prescribed period. If the payment is not done then the deduction is either not at all available or available in the year of the payment. Few of the existing transactions which are covered by section 43B include interest payable to Banks/NBFC, Tax payment, Payment towards PF/ESIC, etc.
Finance Bill – 2023 has proposed to widen the scope of section 43B by incorporating payments to micro and small enterprises also in line with the provision of MSMED Act. As a result, deduction for purchase of any goods/services availed from Micro and Small Enterprises shall be allowed only if the payment is actually made within the prescribed time frame of 15 days or 45 days as discussed above.
Unlike other items of section 43B like bank interest, tax payment, etc wherein the deduction is available if the payment is done on or before the due date of filing the income tax return, the payment to Micro & Small enterprises shall not be admissible as deduction if the same is paid after the end of the financial year and the period of 15 days or 45 days is over. Deduction is admissible only if the payment is either done in the same financial year or within a period of 15 days or 45 days if the same is falling due after 31st March.
Impact of the Proposal:
- If any business entity has made purchase of any goods/services from a Micro or Small enterprise and the paymentfor such purchases or services has not been made during the year and it is outstanding as on 31st march (except where such outstanding payments as on 31st March are falling within the period of 15 days or 45 days from the date of 31st March and payment of the same is made in the subsequent period within the appointed date of 15 days or 45 days), the same will not be allowed as a deduction while computing business income. As a result, taxable income will go up.
- Even though the intent of the Government is good, the impact may be devastating for the business houses. Though the mutual terms and conditions of payment may be different, yet the provision of MSMED Act & Income Tax Act will prevail over it.
- Let us consider the case of a partnership firm M/s B who has purchased the goods from M/s. A for Rs. 1 Cr on 10.02.2024. M/s. B has thereafter supplied the goods to either some Government agencies or to some other person Say M/s. C for Rs. 1.05 Cr. In the process, M/s. B has earned a profit of Rs. 5 Lakh. Now, B has to ensure that the payment is done to M/s. A before 31stMarch 2024 failing which the deduction towards purchase expenses of Rs. 1 Cr shall not be available to M/s. B. If B fails to make the payment before 31st March 2024, income of M/s. B shall be treated as Rs. 1.05 Cr & the resultant tax liability of M/s. B shall be Rs. 32.76 Lakh (i.e., Rs. 1.05 Cr * 31.20%). Though the actual income is only Rs. 5 Lakh (on which the actual tax liability would have been Rs. 1.56 Lakh), the tax liability shall be Rs. 32.76 Lakh i.e., the tax liability could be even more than the amount of the income. Surprising, isn’t it? The blockage of additional funds of around Rs. 30 Lakh towards the tax liability may be another reason for default in subsequent transactions of M/s B.To move little forward, if M/s. A might have also purchased the goods from some other micro/small enterprises and if it fails to make the payment before 31st March 2024 due to liquidity crunch created by default by M/s. B, he would also be subject to the similar disallowance. In short, the new law may have the cascading effect which is likely to stretch beyond one level.In the above case, suppose M/s. B makes the payment on 1st April 2024, then the deduction of Rs. 1 Cr shall be available in the FY 2024-25 which may have the effect of converting the income of M/s B in negative in that FY. Though the benefit of carry forward of loss will be available M/s. B, the fact remains that the loss is not allowed to be carried forward beyond 8 years. The impact of loss could even be so deep in any particular year that the loss may even remain unabsorbed for the next 8 years resulting in ultimate denial of the benefit of loss set off fully.
- The objective of the law is to ensure the timely payment to all Micro and Small enterprises. However, the impact may be hurting for other MSME or large scale enterprises. There are the chances that in an attempt to help the Micro & small enterprises, the other units may land in trouble. The extra tax cost of Rs. 30 Lakh in the above example of M/s B is just one instance and the aggregate impact of other transactions could even be more than what is discussed above.
- There may be instances wherein due to genuine reasons like fire, machine breakdown, court order, etc as a result of which any one buyer in the chain may not be able to make the payment within the appointed due date. However, there is no exception or immunity even in such a genuine or reasonable case. The cascading impact may even be more than what one can think of as each preceding supplier in the chain may default in making payment to its vendor.
- The concept of taxation on real income is getting defeated by widening the scope of section 43B unnecessarily. Further, the mercantile system (i.e., accrual system) of accounting is turning out to be detrimental to the business.
- The provision may have an adverse impact on micro and small enterprises as the buyer may prefer to purchase from those who are not registered as Micro or Small enterprises underthe MSMED Act.
Ensuring the timely payment to Micro & Small enterprises through the Income Tax Act will defeat the very purpose of collecting the tax on actual income. Let the MSMED Act take care of the purpose of ensuring the timely payment. In my considered opinion, the ultimate beneficiary by the above amendment would be the tax department and not the Micro & Small Enterprises. Considering the adverse impact the provision may carry, the proposal to widen section 43B by incorporating the payment to MSME may be dropped.