Section 43B of Income Tax Act, 1961: Know All About It

Of the five different heads of income recognised under the Income Tax Act , income categorised as profits and gains of business or profession is often the most complex. This is because the taxation of business income also involves recognising the expenses that can be deducted from such income. In this regard, section 43B of the Income Tax Act is particularly important.In this article, we examine what section 43B of the Income Tax Act entails, which expenses are allowed as a deduction under this section and the latest update to this provision in the Union Budget 2024.

Section 43B of the Income Tax Act outlines certain specific expenses that can be claimed as deductions from business income. However, these expenses are only deductible in the assessment year in which they are actually paid. Taxpayers cannot deduct them in the year in which they are incurred or due.For any individual or person reporting income under the head of profits and gains of business or profession, it is essential to know what the expenses deductible under section 43B of the Income Tax Act are.Let us discuss an example to better understand how the deduction under section 43B of the Income Tax Act works. Say a business has availed a loan from a bank but there has been a delay in the repayment of Rs. 2,00,000 worth of interest, which was due on January 31, 2022 (i.e. in FY 2021-22). Instead, the business repays this amount only on June 15, 2022 (i.e. in FY 2022-23). So, as per section 43B of the Income Tax Act, this expense can only be claimed as a deduction in FY23 and not in FY22. Also Read: A Guide to Tax Saving Under Section 10 (10D) of Income Tax

Not all expenses are allowed as deductions in the year of payment. As per section 43B of the Income Tax Act, only the following types of expenses can be deducted from business income in the year in which they are paid.

1. Payment of Statutory Dues Any sum paid as taxes to the central or state governments can be claimed as a deduction under section 43B of the Income Tax Act in the financial year during which it is actually paid. These taxes include Goods and Services Tax (GST) , customs duty, cess and even the interest paid on any such tax liabilities .
2. Contributions Made to Employee Welfare Funds Any sum that an employer pays as a contribution to an employee welfare fund is also eligible for deduction under section 43B of the Income Tax Act. Some examples of such funds include the Employee Provident Fund (EPF) , any gratuity or superannuation fund or other provident funds.
3. Leave Encashment Payments Section 43B of the Income Tax Act also covers any payment made by an employer to settle an employee’s leave encashment claims . The employing business can only deduct this expense from its business income once the encashment amount has been paid.
4. Payment of Bonus or Commission Under section 43B of the Income Tax Act, any sum paid by an employer as a bonus or commission to an employee is also deductible from the business income on the basis of actual payment. However, such bonus or commission should not have been paid in the form of dividends on the shares held by the employee, if any.
5. Payments Made to Indian Railways Any amount paid to the Indian railways is also deductible under section 43B of the Income Tax Act. These expenses are also allowed in the year of payment and not in the year they have accrued or are due.
6. Interest Paid on Loans Businesses rely on loans and advances of different kinds to carry out their operations and meet their cash flow requirements. The interest paid on these loans is also covered under section 43B of the Income Tax Act.More specifically, as per section 43B of the Income Tax Act, the interest paid on any loan availed from State Financial Corporations (SFCs), Public Financial Institutions (PFIs), State Industrial Investment Corporations (SIICs) or scheduled banks is deductible from the business income when paid.
7. Payments Made to Micro and Small Enterprises Any expense or sum that is to be paid to micro or small enterprises can be claimed as a deduction as per section 43B of the Income Tax Act only if it is paid within the time frame specified u/s 15 of the MSMED Act, 2006.

The Union Budget 2024 introduced some updates to the MSME payments deductible under section 43B of the Income Tax Act. Only payments made to micro enterprises and small businesses are eligible for the deduction. Medium-sized enterprises are not covered under section 43B of the Income Tax Act and any payments made to such enterprises do not qualify for the deduction.To obtain further clarity on section 43B of the Income Tax Act, let us see what micro and small enterprises mean as per the revised classification.

• Micro Enterprises: These are enterprises with an annual turnover below Rs. 5 crore and investments in plant and machinery below Rs. 1 crore.
• Small Enterprises: These are enterprises with an annual turnover that is above Rs. 5 crore but below Rs. 50 crore and investments in plant and machinery that are above Rs. 1 crore but below Rs. 10 crore.

When a taxpayer reporting business income makes any payment to eligible micro or small enterprises, the amount can only be deducted as per section 43B of the Income Tax Act if it is paid within the time frame specified under section 15 of the MSMED Act, which states the following:

• When a supplier provides services or sells any goods to a buyer, the buyer should complete the payment for such goods or services on or before a date the two parties agree on.
• If the two parties do not have any written agreement and if the buyer does not object, the due date for the payment will be 15 days from when the services were rendered or goods were supplied.
• If the two parties have a written agreement, the due date should be within 45 days of rendering the services or supplying the goods.

Also Read: Maximizing Tax Savings: Understanding Sections 80C, 80D, and 80CCD

Section 43B of the Income Tax Act further specifies the conditions under which eligible payments can be claimed as deductions from the business income. These conditions include the following:

• Actual Payment: To claim the deductions specified under section 43B of the Income Tax Act, the payment concerned should have actually been made. Accrued payments or due expenses are not eligible to be deducted unless the payment has been completed.
• Payment Before the Due Date: If there is any due date for the expenses concerned, such payments should have been made before the due date to be deductible under section 43B of the Income Tax Act.
• Mandatory Payment: The payment that is being deducted under section 43B of the Income Tax Act should be mandatory or compulsory. Optional or discretionary expenses cannot be claimed as deductions when paid.
• Evidence for the Payment Made: The employer or business claiming a deduction under section 43B of the Income Tax Act should have evidence of the payment made. This evidence can be in the form of a written document, receipt or any other such paperwork. Cash payments are not deductible under section 43B of the Income Tax Act.

To ensure that you make the most of section 43B of the Income Tax Act without claiming ineligible expenses, you must also be aware of the exceptions under this provision. Here are the details of these exceptions.

• The assessee should maintain books of accounts and follow the mercantile system for this purpose
• The payments being claimed as deductions under section 43B of the Income Tax Act should have been made on or before the due date for filing the Income Tax Return (ITR) .
• The assessee is required to submit proof of the payment when filing their ITR for the assessment year.

• Taxpayers Adopting the Accrual System Assessees reporting business income and following the accrual system of accounting can leverage section 43B of the Income Tax Act if they adhere to the following conditions:
• Interest Due Converted into a Loan When any interest liability is converted into a loan, it is not considered an eligible payment under section 43B of the Income Tax Act. It can only be claimed as a deduction in the year in which the business repays the converted loan.
• Interest Due Converted into Share Capital Any interest due that is converted into share capital by a business cannot be claimed as a deduction under section 43B of the Income Tax Act. So, if a company converts a portion of the interest due on eligible loans into share capital, such interest will not be deductible from the company’s business income.

This sums up the fundamentals of section 43B of the Income Tax Act for any assessee reporting business income during a financial year . If you also have income under the head of profits and gains of business or profession, ensure that you keep these provisions in mind. This will help you claim eligible expenses as a deduction as per section 43B of the Income Tax Act, so your overall tax burden can be reduced. It will also ensure that you do not claim ineligible expenses and risk receiving a notice from the Income Tax Department.Ready to make the most of your money? Start your tax planning journey now!