Last updated: December 12th, 2024 2:12 PM

Section 43B of Income Tax Act, 1961 - Deductions & Exceptions

Section 43B of the Income Tax Act provides specific guidelines for claiming deductions under the head 'Income from business and profession'. This provision stipulates that certain statutory expenses can only be deducted from business income in the year they are paid, not as they are incurred. According to the Income Tax Act, 1961, individuals can only claim payments as deductions on an "actual payment basis" during the relevant financial year. This means that even if an expense is accrued, it cannot be claimed as a deduction until paid. This article gives you a good deal of understanding of the limitations and applicability of Section 43B of the Income Tax Act. File your ITR seamlessly with IndiaFilings and stay ahead with tax benefits under Section 43B! [shortcode_102]

What is Section 43B of Income Tax Act?

Section 43B of the Income Tax Act deals with the treatment of payments made towards statutory dues, such as taxes, duties, and contributions related to business or professional profits and gains. As mentioned, it mandates that these payments can only be claimed as expenses in the year they are paid rather than in the year they were incurred. This provision ensures businesses cannot defer tax liabilities or use accrued amounts as deductions in financial planning. Section 43B aims to maintain fiscal discipline and prevent tax evasion by aligning the deduction with actual cash flow.

Benefits of Section 43B of Income Tax Act

Here are the several benefits of Section 43B of Income Tax Act, 

• Encourages Timely Payments: Deductions for specific expenses are allowed only when paid, ensuring that businesses make timely payments to creditors, employees, and the government.
• Prevents Tax Evasion: Section 43B discourages businesses from claiming false or deferred deductions by linking deductions to actual payments.
• Improves Cash Flow Transparency: Ensures businesses report accurate cash outflows, promoting better financial discipline.
• Compliance with Statutory Obligations: Encourages adherence to statutory dues like taxes, employee contributions, and duties, strengthening compliance with legal requirements.
• Supports Employee Welfare: Provisions like deductions for employee benefits ensure that businesses prioritise timely remittance of employee contributions to funds like PF and ESI.
• Reduction in Disputes: Since deductions are allowed only on payment, it minimises disputes over accrual-based deductions.
• Promotes Ethical Practices: Ensures businesses follow fair accounting practices by recognising expenses only when paid.

Deductions under the Section 43B of Income Tax Act

Section 43B of the Income Tax Act specifies that certain expenses are deductible only when paid, ensuring timely compliance with statutory and financial obligations. The key deductions allowed under this section are as follows:

1. Taxes, Duties, Cess, or Fees: Any tax, duty, cess, or fee payable under applicable laws is deductible only upon actual payment. This includes levies such as GST, customs duties, and associated interest amounts.
2. Employer Contributions to Employee Benefit Funds: Contributions by employers to recognised funds such as Provident Funds, superannuation, or gratuity funds are deductible if the payment is made by the statutory due date or before filing the income tax return.
3. Bonus or Commission to Employees: Bonuses or commissions paid to employees are eligible for deduction only on actual payment. However, this provision does not cover dividends distributed to employees as shareholders.
4. Interest on Borrowings: Interest on loans from Public Financial Institutions or State Financial Corporations qualifies for the deduction, provided the payment is made per the terms of the loan agreement.
5. Interest on Bank Loans and Advances: Interest paid on loans or advances from scheduled banks is deductible if the payment conditions specified in the loan agreement are met.
6. Leave Encashment: Payments made to employees for leave encashment are deductible when they are disbursed.
7. Payments to Indian Railways: Payments made to the Indian Railways are eligible for deduction under this section, provided they are paid during the financial year.
8. Overdue Payments to Micro and Small Enterprises: Payments due to micro and small enterprises that exceed the time limit specified under Section 15 of the MSMED Act are deductible only upon actual payment.

Important Note: If interest payable under clauses 4 and 5 is converted into a loan, it will not be considered a deductible payment. Businesses, particularly those using the mercantile accounting method, must ensure compliance with these provisions to claim the deductions allowed under Section 43B.

Types of Payments covered in the Section 43B of Income Tax Act

Section 43B of the Income Tax Act governs seven specific types of payments that are eligible for deductions on an actual payment basis. Here is an in-depth overview of these payment categories:

1. Contributions to Employee Benefit Funds: Employers can claim deductions for amounts contributed to employee welfare funds, such as:
   • Gratuity
   • Provident Fund
   • Superannuation Fund However, these payments must be made within the statutory due date or before filing the income tax return.
2. Tax Payments: Taxes, cess, or duties paid to the government are deductible under Section 43B. This provision also includes any interest paid on such tax liabilities.
3. Bonus or Commission to Employees: Bonuses or commissions paid to employees for their services are covered under this section. However, dividends distributed to shareholders are excluded from this category.
4. Interest on Loans and Advances: Deductions are allowed for interest paid on loans and advances obtained from scheduled banks, provided the payment adheres to the terms and conditions stipulated in the loan agreement.
5. Leave Encashment: Payments made to employees for encashing their unused leave balances are included under Section 43B.
6. Payments to Indian Railways: Expenses incurred through payments made to Indian Railways qualify as deductions. However, these payments must pertain to the fiscal year 2016-17 or later. Delayed payments beyond the return filing deadline are allowed as deductions only in the year of actual payment.
7. Interest Payable on Loans from Financial Institutions: Interest on loans from state financial corporations or public financial institutions is deductible, subject to compliance with the prescribed loan guidelines.

Conditions to Claim Section 43B of Income Tax Act

Taxpayers must meet the following conditions to claim deductions under Section 43B:

• Actual Payment Requirement: Deductions are allowed only for payments made during the same financial year, not merely accrued. For example, if an employer declares a bonus but pays it in the next fiscal year, the deduction cannot be claimed for the first year.
• Payment Deadlines: Payments must be made by the stipulated deadline under the relevant statute. For instance, ESI contributions must be deposited by the 15th of each month to qualify for deduction.
• Mandatory Employer Obligations: The payment must be a mandatory obligation rather than a discretionary one. For example, the employment contract should specify any commission paid to an employee.
• Documentary Evidence: Payments must be supported by written documentation. Cash payments are not eligible for deductions under Section 43B.
• Accounting System: Deductions apply only to taxpayers who follow the mercantile accounting system.
• Timing of Expenses: All eligible expenses must be paid on or before the due date for filing income tax returns as specified in Section 139(1) of the Act.
• Proof of Payment: Taxpayers are required to provide substantial evidence of these payments when filing their income tax returns.

Notes on Exceptions under Section 43B:

• Conversion of interest liabilities into share capital does not qualify as an actual payment and is therefore not eligible for deductions under Section 43B.
• Payments made on or before the due date for filing income tax returns are exempt from certain conditions specified in Section 43B.

Budget 2024 - Section 43B of Income Tax Act Amendment

The Budget 2024 introduced significant amendments to Section 43B of the Income Tax Act, focusing on timely payments to micro and small enterprises (MSEs). These changes aim to promote financial discipline among businesses and ease the financial strain on MSEs by incentivising prompt payments.

Section 43B of Income Tax Act MSME

The amendment under Section 43B now applies to any outstanding amounts owed by an assessee to micro or small enterprises that remain unpaid beyond the deadline specified in Section 15 of the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006. It is important to note that this provision exclusively applies to micro and small enterprises, excluding medium-sized businesses. ‘As per Section 15 of the MSMED Act, 2006, buyers must pay suppliers within the agreed-upon timeframe. If a written agreement exists, the maximum permissible period is 45 days from the delivery date of goods or services. Without a written agreement, the payment must be made within 15 days unless the buyer raises a dispute.’ The amendment introduced in April 2023, under Clause (h) of Section 43B, mandates that any payment outstanding beyond 45 days to micro or small enterprises will only be eligible for tax deduction upon actual payment. This provision encourages prompt settlements, fostering better financial health for MSEs and ensuring timely cash flow. Learn more: Section 43B(h) - New MSME 45 Days Payment Rule

Conclusion

In conclusion, Section 43B of the Income Tax Act is a crucial legislative tool to ensure fiscal discipline and transparency in business transactions by linking deductions to actual payments. The recent amendments introduced in Budget 2024, mainly focusing on micro and small enterprises (MSEs), further reinforce this principle. Mandating timely payments to MSEs as a condition for claiming tax deductions aims to alleviate financial pressures on these enterprises, promote ethical business practices, and ensure compliance with statutory obligations. Simplify your income tax filing process—choose IndiaFilings for accurate and reliable ITR filing support! [shortcode_102]