MSE Payments: Businesses Navigate New Tax Law

The new tax law under Section 43B (h) of the Income Tax Act, which mandates payment to micro and small enterprises (MSEs) within 45 days of delivery to claim deductions, is causing concern and leading to various strategies by businesses and vendors to mitigate its impact. The law aims to ensure timely MSE payments and prevent their exploitation by large buyers. However, some companies are attempting to avoid the law’s impact by sending letters to vendors without expecting responses, while others are issuing post-dated cheques or raising objections within 15 days of delivery to delay payment obligations. The government is also being urged to intervene and clarify the law’s applicability and consequences.

The Rationale and Implication of the New Tax Law

Section 43B (h) of the Income Tax Act was introduced in the Finance Act, 2020, with an aim to ensure timely payment of dues to MSEs and prevent their exploitation by large buyers. The section provides that any sum payable by an assessee to a supplier, being a micro or small enterprise, shall be allowed as a deduction only in the year of actual payment, if such payment is not made within 45 days from the date of acceptance or deemed acceptance of goods or services.

This means that if a business entity fails to pay its vendors registered as MSEs within 45 days of delivery, it will not get the deduction of its purchase in the year of the purchase but can claim the deduction only in the year of actual payment. This would increase the taxable income and tax liability of the business entity for the financial year 2023-24. This would also affect the cash flow and working capital of MSEs, who depend on timely payments for their survival and growth.

The Challenges and Strategies for MSE Payments

The new tax law has created a lot of confusion and uncertainty among businesses and vendors, as there are many practical difficulties and ambiguities in its implementation. For instance, there is no clear definition of what constitutes ‘acceptance’ or ‘deemed acceptance’ of goods or services, which determines the start of the 45-day period. There is also no mechanism to verify whether a vendor is registered as an MSE or not, as there is no central database or portal for this purpose.

Many businesses and vendors are trying to escape the impact of the new tax law in different ways, some of which may not stand the scrutiny of the auditors and tax authorities. Some of the strategies adopted by them are:

• Sending registered letters to vendors asking them if they are classified as MSEs with a tacit understanding that the latter would not respond. In the absence of a response, the vendor is not considered as a government-registered MSE and the purchases are treated as deductible.
• Issuing cheques to suppliers and showing the payment in the books with the understanding that the suppliers would deposit the cheques only on the agreed dates. This would delay the actual payment and avoid deduction disallowance.
• Raising objections within 15 days from the delivery of goods or services, in which case the payment obligation would arise only when the issue is resolved. This would extend the 45-day period and allow more time for MSE payments.
• Asking the micro or small suppliers to surrender their MSME registration or reclassify themselves as trading entities instead of manufacturing entities. This would make them ineligible for the benefit under Section 43B (h) and exempt them from MSE payments.

These strategies may help businesses and vendors temporarily avoid or delay MSE payments, but they may also expose them to legal risks and reputational damages in the long run.

The Government’s Response and Suggestions for Improvement

The government has not yet issued any clarification or amendment to Section 43B (h) of the Income Tax Act, despite several representations and requests from various industry associations and stakeholders. The government has also not announced any relief or exemption for businesses affected by the Covid-19 pandemic, which has disrupted their cash flows and operations.

Many experts and analysts have opined that Section 43B (h) of the Income Tax Act is a well-intentioned but poorly drafted law, which needs urgent revision and simplification. They have suggested that instead of disallowing deductions for unpaid purchases, the government should impose interest or penalty on delayed MSE payments, which would be more effective and fair. They have also recommended that the government should create a central portal or database for MSE registration and verification, and provide clear guidelines on what constitutes acceptance or deemed acceptance of goods or services.

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