Profits and gains of business or profession (PGBP) is computed on the basis of either “Cash or Mercantile” system of accounting followed by the assessee. In the case accounting method, the income and expenses are accounted on the basis of cash inflows and cash outflows respectively. In the mercantile system of accounting, income and expenses are accounted on the accrual basis.
The Income Tax Act allows deduction of expenses/expenditures on the basis of system of accounting followed. The deductions play a crucial role in minimizing your taxable income. Section 43(b) of the Income Tax Act, 1961, is one such provision that governs specific deductible expenses for businesses and professionals. Unlike the general rule of accrual accounting, where deductions are allowed in the year the expense is incurred, Section 43(b) mandates claiming these deductions only in the year of actual payment of expense. This section applies to amount outstanding at the year end and paid off after 31st March of the financial year. This applies to a specific list of expenses including:

a. Amount payable by way of tax, duty, cess or fee, under any law for the time being in force, or

b. Amount payable by an employer by way of contribution to any provident fund or
superannuation fund or gratuity fund or any other fund for the welfare of employees, or

c. Bonus or commission payable to the employee for the services rendered, or

d. Amount payable as interest on any loan or borrowing from any public financial institution or a
State financial corporation or a State industrial investment corporation, or

e. amount payable as interest on any loan or borrowing from a deposit taking NBFC or nondeposit – taking NBFC, or

f. amount payable as interest on any loan or advances from a scheduled bank or a co-operative
bank other than a PACS or PCARD Bank, or

g. Leave encashment payable to the employee, or

h. Amount payable to the Indian Railways for the use of railway assets, or
The below mentioned clause has been inserted to Section 43B by the Finance Act, 2023, w.e.f
01-04-2024.

i. Amount payable to a micro or small enterprise beyond the time limit specified in section 15
of the Micro, Small and Medium Enterprises Development Act, 2006.

The above said payments shall be allowed as deductions in the previous year in which such sum is actually paid by the assessee, irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him.

It is noteworthy that Section 43B allows a deduction of year-end outstanding on an accrual basis if the payment is made on or before the due date of filing the ITR, for all the above-mentioned points covered under points (a) to (h), except for point (i), the sum payable to micro and small enterprises.

For example: Mr.X’s liability towards commission payable to employees as at 31st March 2024 Is INR. 50,000/-. The amount is paid on 31st May 2024. In this case, while computing taxable business income of Mr.X, the amount of INR 50000 commission payable as at 31st March 2024 is deductible on an accrual basis as the payment towards such liability is remitted within the due date of filing the return of the assessee, i.e 31st July 2024.
Analysis of the amendment brought in by The Finance Act 2023 – The sum payable to a micro or small enterprise (MSEs) beyond the time limit specified in Section 15 of the Micro, Small and Medium

Enterprises Development Act 2006 (MSMED Act) shall be allowed as a deduction in the previous year in which such sum is actually paid.

Meaning of Micro and Small Enterprises:
The meaning of Micro and Small Enterprises are as per the MSMED Act.
Any class or classes of manufacturing or service enterprises, whether proprietorship, HUF, association of persons, co-operative society, partnership firm, company or undertaking, by whatever name called, shall be categorized as:
                 a. Micro Enterprises,
If Net investment in plant and machinery or equipment of such entity does not exceed Rs 1 crore; and
Its Net turnover does not exceed Rs 5 crores.
                b.Small Enterprises,
If Net investment in plant and machinery or equipment of such entity does not exceed Rs 10 crore; and
Its Net turnover does not exceed Rs 50 crores.
To invoke invoked for disallowance under Section 43B of the IT Act, such micro and small enterprise should be registered on the Udyam portal and applies to the supplies of goods or services made after obtaining the Udyam registration.

Understanding Net Investment & Net Turnover:
Net Investment in plant and machinery or equipment would be equivalent to the depreciated cost of plant and machinery or equipment as per the previously filed ITR, further reduced by the costs associated with pollution control, research and development, and industrial safety devices.
Net Turnover would refer to the turnover of goods and services reduced by the amount of the exports of goods and services. Such amount should be linked to Income Tax Act & GSTIN.

Limitation Period as per MSMED Act
As per the MSMED Act section 15, the time limit to make payment to the supplier for the buyer of any purchase of goods and service is on or before the date agreed upon between the two. Such time period should not exceed 45 days.
The buyer is required to make the payment on the “appointed day” if there is no agreement between the parties.
“Appointed day” means the day immediately after the expiry of the period of 15 days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier.

Illustrations:
Mr. A buy and accepts the goods on 25th March 2024. The due date of payment as per MSMED Act would be as follows:
If the credit period allowed is 25 days as per the agreement, the due date as per Section 15 would be 19th April 2024.

If the credit period allowed is 60 days as per the agreement, the due date as per Section 15 would be 8th May 2024, as the time limit cannot exceed 45 days.
In case of absence of agreement, the due date as per Section 15 would be 8th April 2024, i.e 15 days from the date of acceptance.
If the payment is made within the above said due dates, there shall be no disallowance under Section 43B.
Suppose in the above example, where the credit period is 60 days, and the due date as per Section 15 of MSMED Act is 8th May 2024 if the payment is made to the supplier on 31st May 2024, would there be a disallowance?
If the amount payable as at the end of the year is settled after the time limit specified as per Section 15 of MSMED Act, such amount shall be disallowed for that financial year, in this case for FY 2023-24. However, such amount shall be allowed while computing the taxable business income for the next FY on the actual payment basis.

Would disallowance be attracted in the Illustration 2, if payment is made by way of cheque dated 8th May 2024 and is handed over to the supplier within the due date as per MSMED Act, however cheque is encashed after the due date?
No disallowance will be attracted.

On 25th March 2024, instead of crediting the individual creditors account, the provision entry has been passed. Would disallowance attract u/s 43B?
Provisions represent sums payable in respect of which deduction is otherwise allowable under the Act. Hence, they would fall within the ambit of Section 43B.

Mr. A gives an advance of INR 1 lakh to Mr B (Micro enterprise) on 31st March 2024, for the services to be rendered in the month of May 2024. Can Mr. A claim deduction in respect of such advance payment while computing taxable income for FY 2023-24?
Such advance payment shall be allowed as a deduction in the FY 2023-24, i.e in the year of payment irrespective of the fact that it is towards the services to be rendered for FY 24-25. This is in line with the judgments of the Apex court in respect of deduction u/s 43B for the advance payments.

Mr. A owes INR 50000 to Mr. B ( Small enterprise) towards the capital expenditure incurred. 100% deduction is allowed under the Act for such capital expenditure. As at the end of the FY, the amount is outstanding and the payment is made only after the time limit specified u/s Section 15 of MSMED Act. Is Disallowance attracted u/s 43B?
Section 43B(h) applies to sum payable to micro or small enterprises with respect to the purchase of capital goods for which a 100% deduction is admissible under Sections 30 to 36. Hence, the disallowance is attracted.

Mr. A buy and accepts the goods on 1th April. As per the agreement, the credit period of 15 days.
The invoice was settled by Mr. A on 31st March 2024.
The invoice was settled by Mr. A on 30th April 2024. Would there be a disallowance in case (a) or (b)?

In case (a) even though the payment is made after the time -limit as per Section 15 of MSMED Act, there would be no disallowance, as the payment is made within the same financial year and there is no balance outstanding as at the end of the year. However, interest as per Section 16 of MSMED Act would attract.
In case (b) there would be disallowance for FY 2023-24, as the amount is outstanding at the end of the year and payment has not been made within the time limit as per Section 15. However, such amount shall be allowed as deduction for FY 2024-25.

Sum payable to retail traders & Wholesalers – Whether attracts Section 43B disallowance?

Although Retail and wholesale traders are considered as MSMEs and are allowed to be registered on Udyam Registration Portal, only the benefit of priority sector lending is made available to them. If the Udyam Certificate of a micro or small supplier shows his activity as only a trader, then he is NOT considered as a supplier for section 15 and section 43B.
Understanding Section 43(b) empowers you to make informed decisions to optimize your tax liability. We can guide you on applying Section 43(b) effectively and optimize your tax deductions within the legal framework. Feel free to reach out to us.