Understanding MSME Payment Rules: Section 43Bh Explained

The MSME 45-day payment rule was introduced by the 2023 Finance Act, under section 43B(h) of the IT Act. The newly established rule states that any payment due to MSMEs, if paid during the timeline of 46 days, is eligible for deductions in the same financial year. However, in case payments are delayed and paid after 45 days, the deductions will be allowed for that financial year in which the payment was made. The goal behind this MSME payment rule was simple: to improve the cash flow for MSMEs, create a better MSME ecosystem, reduce the chances of disputes, and much more.

Continue reading to know more about MSME payment compliance, why it matters, how it benefits, MSME payment penalties, and much more. 

Background of the New GST Return Filing System

The new GST return filing system introduces a revised classification for taxpayers based on their annual turnover. This change aims to simplify the tax filing process, particularly for smaller businesses. Under this system, businesses are categorised as follows:

• Small Taxpayers: These entities have an aggregate annual turnover of up to ₹5 crores in the previous financial year. Most MSMEs fall into this category. 
• Large Taxpayers: This group includes businesses with an aggregate annual turnover exceeding ₹5 crores in the preceding year. 

One of the key features of this new system is the flexibility it offers to small taxpayers. They now have the option to file their GST returns quarterly. This can significantly reduce their compliance burden. In contrast, large taxpayers are required to continue with monthly return filing. 

Another important aspect of the new system is the mechanism for claiming input tax credit (ITC). Registered buyers can now claim ITC in their ANX-2 form only for invoices that their suppliers have uploaded to their corresponding ANX-1 forms. This change aims to improve the accuracy of tax credits and reduce discrepancies in the system. 

Background of the MSMED Act, 2006

The MSMED Act, 2006, was established to protect micro, small and medium enterprises from delayed payments. It ensures financial stability. The law mandates payments within 45 days to prevent cash flow issues. To strengthen enforcement, the MSME Samadhaan portal was launched on October 30, 2017. It helps track MSME payment timelines and allows businesses to register complaints against delayed payments by government entities like Central Public Sector Enterprises (CPSEs) and state departments. 

Understanding the 45-Day and 15-Day Payment Cycle

The MSMED Act introduces specific MSME payment guidelines to safeguard the financial interests of MSMEs. These terms are crucial for both suppliers and buyers to understand:

• In the absence of a mutually agreed-upon payment date, buyers must abide by the MSME 45-day payment rule. They should settle their dues to MSME suppliers within 45 days of receiving goods or services. 
• Even if a buyer and an MSME supplier agree on a credit period exceeding 45 days, the MSMED Act overrides this agreement. It mandates that payment must still be made within the 45-day window of the date of receipt of goods or services. 
• In scenarios where no specific credit period has been agreed upon, the MSME regulations stipulate an even shorter payment window. In such cases, buyers are required to make payments to their MSME suppliers within just 15 days of receiving the goods or services. 

The clearly set MSME payment timeline aims to ensure a steady cash flow for MSMEs. It enables them to maintain their operations and growth without the burden of extended payment cycles. 

Objectives of the MSME Payment Rule

Here is how the introduction of new MSME payment regulations can help MSMEs. 

• Timely Payments: Ensures businesses clear dues within 45 days, stabilising cash flow for micro enterprises.
• Boost MSME Growth: Quick payments allow businesses to expand and apply for a small business loan when needed. 
• Fair Business Practices: Prevents the delayed payments that small businesses face, ensuring a level playing field. 
• Compliance and Transparency: Businesses must track their payment schedule to follow the rule.
• Encouraging Sustainability: Ensures a predictable income flow, helping MSMEs meet expenses like rent and pay taxes. 

Key Components of MSME Payment Rule

• Payment Deadline: Payments to MSMEs must be made within 45 days of invoice issuance. 
• Applicability: The rule applies to public and private firms engaging with MSMEs, including those seeking a loan for business. 
• Penalties for Delay: Late payments incur legal action and interest, affecting access to business loan government initiatives. For instance, there are negative tax implications on MSME delayed payments. The compound interest rate for delayed MSME payments is three times the bank rate as per the RBI notification.
• Invoice Tracking: MSMEs should use tools for tracking payment cycles to stay compliant. 
• Dispute Resolution: A structured system helps resolve conflicts quickly, protecting business loan companies and MSMEs alike. 

Changes that Come into Effect from 1st April 2024

With the new financial year starting, businesses must gear up for significant changes in MSME payment terms to manage their accounts payable. This is particularly true when dealing with MSME suppliers. These adjustments will affect how expenses are recognised and the conditions under which they are deductible. Here is what businesses need to prioritise:

• Create a Detailed Vendor List: The first and most crucial step is to create a comprehensive list of all vendors. This is not just about having a simple database of suppliers. Businesses need to go a step further and categorise their vendors, with a special focus on identifying which ones qualify as MSMEs under the MSMED Act. This categorisation is critical because the new rules apply specifically to transactions with registered MSMEs. To do this effectively, businesses should:

• Review all existing vendor contracts and documentation
• Reach out to suppliers to confirm their MSME status
• Update their vendor management systems to flag MSME suppliers
• Implement a process for regular updates of this information, as a supplier’s MSME status can change over time
• Record All Outstanding Payables: Businesses need to compile a detailed record of all outstanding payables as of March 31, 2024. This is not just about knowing the total amount owed; it requires a granular breakdown of:

• The specific amount owed to each supplier
• The date of each invoice
• The due date for each payment is as per the agreed terms
• Whether the supplier is an MSME
• The age of each payable

This detailed record serves multiple purposes as it provides a clear picture of the company’s financial obligations. It helps identify which payables might be affected by the new ones as well as allows for better cash flow management and planning.

• Understanding Allowance and Disallowance Rules: Perhaps the most critical aspect of these changes is understanding how the new MSME payments rule will affect the allowance and disallowance of experts related to pending payments to MSMEs. This understanding is crucial for accurate tax planning and financial reporting. Key points to understand include:

• The 45-day and 15-day MSME payment time limit for suppliers
• The impact of exceeding these limits on tax deductions
• The differentiation between payments made within the same financial year versus those made in subsequent years

Important Points to be Considered for Allowances and Disallowances of Pending Payments as Expenses

Let’s delve into these different payment scenarios and how they will be treated under the new rules:

Situation 1: Same Financial Year Payments

If a buyer pays an MSME supplier within the same financial year, even if it is beyond the 45-day or 15-day limit, the expense can still be claimed as a deduction in that year itself. This scenario provides some flexibility for businesses that might occasionally exceed the payment limit but still manage to settle their dues before the financial year ends. 

For example, if a company receives an invoice from an MSME supplier on May 1, 2023, and pays it on February 28, 2025, it is beyond the 45-day limit but within the same financial year. They can still claim this expense as a deduction for the financial year 2024-25. 

Situation 2: Subsequent Financial Year Payments (Beyond Stipulated Period)

For payments made to MSMEs beyond the stipulated period and in a subsequent financial year, the deduction can only be claimed in the year of the actual payment. This scenario is designed to discourage delayed payments that stretch beyond the financial year. 

For instance, if a company receives an invoice on February 1, 2025, but only pays it on April 15, 2025, it falls in the next financial year and beyond the 45-day limit. The company can only claim this expense as a deduction in the financial year 2025-26, even though the expense was incurred in 2024-25.

Situation 3: Next Year Payments Within Approved Credit Period

When expenses are accrued in one financial year, but payment is made in the next year within the MSME Act’s approved credit period, the deduction can be claimed in the year of accrual. This scenario recognises that some payments might legitimately fall into the next financial year due to the timing of invoices near the year-end. 

For example, if an MSME invoice is received on March 15, 2025, and paid on April 20, 2025, it is within the 45-day limit. However, it falls in the next financial year. This expense can still be claimed as a deduction for the financial year 2024-25. 

Situation 4: Subsequent Year Payments Beyond Credit Period

If payment is made in the subsequent financial year and beyond the MSME Act’s credit period, the deduction is only allowed in the year of the actual payment, not on an accrual basis. This scenario is the most stringent and is designed to strongly discourage late payments to MSMEs. 

For instance, if an invoice is received on January 15, 2025, but only paid on May 30, 2025, it is both in the next financial year and beyond the 45-day limit. This expense can only be claimed as a deduction in the financial year 2025-26.

These scenarios highlight the importance of timely payments to MSME suppliers. Businesses that fail to pay within the stipulated periods risk losing the tax deductions in the current year. They also face potential cash flow issues due to the bunching up of tax deductions in future years.

Benefits of the MSME Payment Rule

Here is how the MSME payment rule enforcement helps. 

• Improved Cash Flow: Receiving payments within the deadline ensures liquidity for MSMEs. 
• Faster Reinvestment: Businesses can reinvest earnings in operations instead of struggling with the late payments that small businesses face. 
• Financial Stability: A steady cash flow helps businesses qualify for a same-day business loan when needed. 
• Strengthened Business Relationships: Ensure trust between MSMEs and larger firms, improving business e-transactions.

Impact of Disallowance of Expenses When Bills are Overdue Under Section 43 (b)(H)?

An important point to note is that when payments to MSME suppliers are not made within the prescribed 15-day or 45-day cycle, Section 43 (b) (h) does not grant any disallowance. Instead, the allowance is granted only on an actual payment basis. This means that businesses cannot claim expenses for unpaid MSME invoices until they make the payment. This is regardless of when the expense was incurred. 

Key Points as Per Recent Amendments 

As businesses prepare for these changes, it is crucial to remember several key points:

• Implementation Date: The new MSME payment system for small business rules under Section 43B(h) apply from April 1, 2024, for the 2024-24 assessment year. Non-compliance can result in tax disallowance. 
• Scope of Application: The rule under Section 438 (h) of the Income Tax Act 1961 applies only to micro and small enterprises, not medium enterprises, making it crucial to classify vendors accurately.  
• Delayed Payments: Payments settled before filing business loan government tax returns can be deducted only in that year, reinforcing the need for timely payments. Tracking payment timelines is essential to avoid financial strain.
• UDYAM Registration: Suppliers must inform buyers of their valid UDYAM registration; otherwise, tax disallowances cannot be claimed under Section 438 (h). This affects both the company and MSME suppliers.  
• Retroactive Application: The rule does not affect outstanding dues before March 31, 2023, but applies to all transactions from April 1, 2024. Businesses must adapt their payment within small businesses accordingly.

Challenges and Concerns of the MSME Payment Rule

• Lack of Awareness: Many businesses remain unaware of rules, missing out on benefits like a small business loan scheme. 
• Dispute Resolution Complexity: Lengthy resolution processes impact operations, delaying access to a startup loan. 
• Enforcement Issues: Weak implementation allows larger firms to delay payments despite the law. 

Steps to Ensure Compliance with the Rule

Here is how to comply with the MSME 45-day payment rule without much hassle. 

• Clear Contract Terms: Clearly define payment schedules in agreements to avoid disputes. 
• Invoice Management: Keep records of your payment due dates to streamline operations. 
• Regular Follow-Ups: Consistent communication prevents overdue invoices from affecting working capital. 
• Payment Reminders: Automate reminders to ensure on-time payments and prevent reliance on business loans online. 
• Document Everything: Keep records to provide compliance, protecting eligibility for a business loan for MSMEs. 
• Dispute Resolution Mechanisms: Establish structured systems to resolve payment issues quickly. 

Conclusion

New amendments under Section 43B(h) impact how businesses handle MSME payments. MSME payment Compliance ensures smoother transactions and better tax benefits, reducing the need to apply for business loans online. Have your MSME compliance checklist ready to avoid any hassle. For instance, setting payment reminders, follow-up regularly, and having your documents ready can help. Further, staying informed and adjusting payment practices as per the MSME payment deadlines can help businesses avoid financial penalties. Rely on Lendingkart for valuable resources and insights to support businesses in understanding these changes and staying compliant.