Deduction of expenses for businesses on payment basis only

While computing income for the source of income from business and profession, certain expenses are allowed as deduction from such incomes or receipts. While doing accounting of such businesses expenses are recorded on accrual or receipts whichever is earlier. Income tax also recognises this principle of accounting and accepts the same.

However, there are certain expenses which can be claimed only in the year in which they are paid and not in the year in which their liability to pay incurs.

Section 43B of income tax delas with the provisions of payments allowed as deductions only on the payment basis.

Section 43B:
Section 43B of the Income Tax Act provides a list of expenses allowed as deductions under the heading ‘Income from business and profession’ only when they are actually paid by the assessee.

Following is a list of expenses where section 43B is applicable for such expenses that are allowed only if dues are paid within the time limit specified in The Income Tax Act:

Any tax, cess, duty, or fee shall be claimed on actual payment basis.
Contributions made by the employer to employees’ PF and ESI funds and other welfare funds can be claimed as a deduction on the actual payment basis.
Bonus or commission payable to employees- this amount should be the actual bonus/ commission paid to employees and not dividends payable to them as shareholders.
Interest on borrowings from Public Financial Institutions or State Financial Corporation or a deposit taking non-banking financial company or systemically important non-deposit taking non-banking financial company in accordance with the conditions governing such loan
Interest on loans and advances from Scheduled Bank in accordance with the conditions governing such loan
Any payment made to the employee for unutilized leaves balance can be claimed as a deduction. However, Payment should have been paid before the due date of filing the ITR
Amount payable to the Indian Railways for the use of Railways Assets.
Any Amount payable to Micro or Small Enterprises shall be allowed as a deduction in the same year only if paid within the time limit specified by the MSMED Act, 2006.(New update)

Clause 43B(h) as amended in Finance Act, 2023

This amendment is applicable to any sum payable by the assessee to a micro or small enterprise beyond the time limit specified under section 15 of the MSMED Act, 2006. This clause only applies to micro and small enterprises, while medium enterprises stay out of the purview of this act.

Section 15 of the MSMED Act determines the time limits for payments to be made to the MSMEs.

Timeframes to make payments to MSMEs when:

Payment terms are specified under an agreement between buyer and the MSEs
Payment should be made within earlier of

Due date as mentioned in agreement
45 days from date of acceptance i.e. date on which actual delivery of goods or services is made

Payment terms are not specified in the agreement
Payment should be made within 15 days of date of acceptance

Conditions for claiming deductions under section 43B:
Following conditions are to be complied mandatorily in order to claim deductions u/s 43B:

There has to be actual payment and not just the accrual of payment.
The payment must have been made on or before the due date specified under respective acts.
Payment is not optional i.e. Payment made by the employer must be mandatory in nature
No payments are made in cash i.e. there must be documentary evidences

It is important to note that converting interest liabilities into share capital is not covered by Section 43B of the Income Tax Act.

Conclusion:
Deduction of expenses mentioned are mandatorily required to be paid within due date in order to ensure timely compliance with the respective authorities. The amendment to clause (h) of Section 43B is an important step in bringing the desired change in payment structure of businesses to ensure timely and prompt payments to MSEs.

Disallowance of expenses upon failure to pay within due date will put additional taxation liabilities on the businesses.

About Author:
CA Chinmay Shirish Agate
Chinmay Agate is a Practicing Chartered Accountant having 4+ years of experience and expertise in the field of Direct Taxation and Auditing compliances. In the past, he worked in various CA firms and comes with wide industry experience from services, retail to manufacturing to trading where he has handled various complex assignments. He has keen interest in Forex and Derivative knowledge as well as fundamental analysis.