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Section 43B(h) of the Income Tax Act states that any payment due to a micro or small enterprise, beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006, shall only be allowed as a deduction when computing income under section 28 of the relevant previous year in which such payment is actually made. This clause essentially disallows expenses that are not settled within the specified time frame outlined in the MSMED Act. Hence, if payments are outstanding as of March 31st and not settled within the stipulated time, such expenses will be disallowed under section 43B(h) during income computation.

The definitions of micro and small enterprises can be found in section 7 of the MSMED Act. Let's delve into the provisions of the MSMED Act, 2006 below.

Section 7 of MSMED Act, 2006 : MSME Definition

The classification of Micro, Small and Medium Enterprises is defined under the MSMED Act 2006 amendment dated 01/06/2020. The Micro, Small and Medium Enterprises is based on the Investment in Plant, Machinery or Equipment values (excluding land and building) and Annual Turnover. This shall come into effect from 01.07.2020.

Section 15: Liability of buyer to make payment

Where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day: Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance.

The above section is summarised as follows:

• As per the MSMED Act, 2006, the payment period is outlined in Section 15, which states that buyers must settle payments for goods or services within the agreed-upon date or within 45 days from the date of acceptance, whichever is earlier.
• If there's no written agreement, payment must be made within 15 days from the appointed date, as defined in Section 2(b) of the Act.

Section 16 Date from which and rate at which interest is payable.

Where any buyer fails to make payment of the amount to the supplier, as required under section 15, the buyer shall, notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the Reserve Bank.

The above section is summarised as follows:

• Failure to adhere to the timelines stipulated under Section 15 of the Act, results in the buyer being liable to pay compound interest at three times the bank rate notified by the Reserve Bank of India (RBI).
• Currently, the RBI's bank rate stands at 6.75%.
• Additionally, under Section 22 of the MSMED Act, if the buyer is subject to audit under any law, they must furnish details of dues to MSMEs, including unpaid or paid interest.
• It's important to note that interest paid or payable is not allowed as expenditure in income computation under Section 23 of the MSMED Act, 2006.

In summary, if payments are not made within the specified time limits, the buyer incurs interest at three times the RBI's bank rate, and such interest is disallowed under the Income Tax Act, 1961. Failure to settle payments within the stipulated time may also lead to the disallowance of expenses under section 43B(h) for outstandings as of March 31st, with allowance made in the year when payment is eventually made.

Whether traders are Covered under Section 43B(h)?

Based on an Office Memorandum from the Ministry of Micro, Small & Medium Enterprises dated July 2, 2021, traders, including those involved in retail and wholesale businesses, have been included as MSMEs and are eligible for registration on the Udyam Registration Portal. However, it's important to note that benefits for traders in the retail and wholesale sectors are limited to Priority Sector Lending only. Therefore, for the purpose of Section 43B(h) of the Income Tax Act, 1961, only manufacturers and service providers are considered covered entities.

Disallowance under Section 40(a)(ia) and 43B(h) Simultaneously

When it comes to disallowances under Section 40(a)(ia) and 43B(h) simultaneously, if TDS isn't deducted and payment isn't made within the stipulated time frame, the disallowance falls under Section 43B(h) rather than 40(a)(ia). This is because no deduction is being claimed, rendering 40(a)(ia) inapplicable.

Applicability of 43B(h) in case of ITR filed under section 44AD or 44ADA

Regarding the applicability of 43B(h) in cases of ITR filed under Section 44AD or 44ADA, there's no disallowance since these sections override Sections 28 to 43C. Therefore, this clause doesn't apply to businesses filing returns under Section 44AD or 44ADA.

Applicability of 43B(h) in case No tax Audit upto turnover of 10 Crores.

Even if there's no tax audit up to a turnover of 10 Crores, Section 43B(h) remains applicable, and its effect should be considered in the computation of income.

I’m a Micro or Small Enterprise will this section apply to me?

If you're a micro or small enterprise, yes, these conditions will apply to you, especially if you purchase goods or services from other micro and small enterprises.

Guidelines for Managing MSME Vendor Relationships and Compliance:

1. Collect MSME Certificates from All Vendors:
• Reach out to each vendor and request a copy of their MSME certificate.
• Ensure that the certificate is valid and up-to-date.
• Maintain a systematic record of all received certificates for future reference.
2. Prepare a List of Vendors with MSME Certificates:
• Create a spreadsheet or database to organize information about each vendor.
• Include details such as vendor name, MSME certificate number, validity period, contact information, etc.
• Regularly update the list as new certificates are obtained or existing ones expire.
3. Execute Agreements or Issue Purchase Orders with Clear Payment Terms:
• Draft agreements or purchase orders outlining the terms of payment, including due dates, payment methods, and any applicable penalties for late payments.
• Ensure that the terms are mutually agreed upon and clearly communicated to vendors.
• Review and update agreements periodically to accommodate any changes in payment terms or business relationships.
4. Ensure Timely Payment in Accordance with Agreed Guidelines:
• Establish internal processes to track payment due dates and monitor payment schedules.
• Allocate sufficient resources and manpower to process payments promptly.
• Communicate with vendors in case of any delays or discrepancies in payments and work towards resolving them promptly.
5. Mention Your MSME Udyog Aadhar Number on All Invoices:
• Include your MSME Udyog Aadhar number on all outgoing invoices issued to customers or clients.
• Ensure that the number is prominently displayed and easily identifiable on the invoice.
• This helps establish your MSME status and facilitates smooth transactions with other businesses.

Additional Points to Consider:

• Regular Communication with Vendors: Maintain open channels of communication with vendors to address any queries or concerns related to payments or business transactions.
• Compliance with Legal Requirements: Stay updated with any changes in MSME regulations or taxation laws that may impact your business operations.
• Building Strong Relationships: Foster positive relationships with vendors by demonstrating reliability, transparency, and fairness in business dealings.
• Evaluation of Vendor Performance: Periodically assess the performance of vendors based on factors such as quality of products/services, adherence to payment terms, and responsiveness to queries.
• Exploring Financing Options: Explore financing options such as invoice financing or supplier credit to optimize cash flow management and maintain healthy vendor relationships.

By adhering to these guidelines and incorporating additional considerations, businesses can effectively manage their relationships with MSME vendors while ensuring compliance with regulatory requirements and fostering mutual trust and cooperation.