Every business can claim deduction of payments made to the vendors on accrual basis. This means that business can claim deduction of payments to vendors which are not paid in actual but are due for payments as on the last date of the financial year and/or even until filing the return of income.

However on the other part where the recipients of such payments are concerned, they face difficulties in recovering such payments especially the small businesses. To remove these difficulties faced by small businesses and to promote timely payments to businesses registered as MSMEs, the Finance Act 2023 included Section 15 of the MSMED Act under section 43B of the Income Tax Act.

As per Section 15 of the MSMED Act, any payments due to micro, small and medium enterprises, such businesses should mandatorily make payments within the time period as per the written agreement between the parties and such time period cannot be more than 45 days. In absence of any written agreement, such payments should be made within 15 days from the date of such payments become due.

Section 43B of the Income Tax Act specifies the list of certain expenditures or payments, the deduction of which can be claimed only in the year in which the payment is made in actual, irrespective of the year in which the liability of payment was incurred. The expenditures or payments listed in section 43B of the Income Tax Act shall be claimed as deduction only upon its actual payment irrespective of the method of accounting followed by the assessee. However, if the assessee follows mercantile system of accounting, such expenses can be claimed as deduction if such payments are made before the due date of filing of return of income u/s 139 (1) of the income tax act.  This provision of claiming deduction of the expenses, the payment of which is done before filing the return of income applies to all the payments as specified except for the payments to MSMEs. In other words, if the payment standing due to an MSME as on 31s March of the previous year is not paid within 15 or 45 days but paid before filing of the return of income cannot be claimed as deduction in the previous year in which the liability was incurred.

Thus as per the Finance Act 2023, any payment due to MSMEs shall fall under the ambit of Section 43B(h) of the Income Tax Act. Accordingly, where any payments due to MSMEs are made beyond the time limit specified in Section 15 of the MSMED Act 2006, can be claimed as deduction only on its actual payment. Thus if any payment made beyond the time limit as specified by Section 15 of the MSMED Act 2006, but before filing of the income tax return shall be claimed as deduction in the year in which the payment is actually made and not the year in which such liability was incurred by the assessee. This provision shall become applicable from 1^st April 2023.

For better understanding of this clause, below is an example and different situations giving the time of liability incurred.

As on 31^st March 2024, ABC Ltd has a liability of Rs 10 lakh to be paid to XYZ ltd. XYZ Ltd is a business registered as Micro, Small and Medium Enterprise (MSME).

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