Query on applicability of TDS u/s 194A on MSME interest (not actually paid)

[Piyush Choudhary]

Hi Folks,

We procure goods from MSME-registered suppliers and, in certain cases, payments are delayed beyond the prescribed 45 days.

As per MSME Act provisions, we recognize interest liability in our books for such delays. Based on this accounting recognition, we are also deducting TDS under Section 194A on the accrued interest.

However, practically, such interest is neither demanded by the supplier nor actually paid.

In this context, I seek expert views on the following:

• Whether TDS u/s 194A is applicable on interest liability recognized under the MSMED Act, even when the same is not actually paid or credited to the supplier's account?
• Does mere book provision for MSME interest trigger TDS liability, especially considering that such interest is often contingent and not contractually enforced?
• Are there any judicial precedents or departmental clarifications on this matter?

Would appreciate insights from professionals who have dealt with similar situations.

[YAGAY and SUN]

The issue for consideration is whether mere accounting recognition of interest liability under the MSMED Act 2006, without actual payment or demand by the supplier, attracts deduction of tax at source under Section 194A of the IT Act, 1961.

Section 194A requires deduction of tax at source at the time of credit of interest to the account of the payee or at the time of payment, whichever is earlier. Jurisprudence under TDS provisions indicates that where liability is ascertained and interest is credited to an identifiable payee, TDS obligation may arise even if actual payment is deferred.

However, interest under Sections 15 and 16 of the MSMED Act operates in a peculiar statutory framework. In practice, such interest is frequently neither demanded nor mutually acknowledged by the MSME supplier, and many entities recognize the same only as a statutory or accounting provision to comply with disclosure and reporting requirements.

A tenable legal position exists that where the provision is contingent, unascertained, or merely notional in nature, Section 194A may not be triggered. Courts in analogous matters have held that TDS provisions do not apply where liability is uncertain, disputed, or where no identifiable payee exists at the stage of provisioning. The underlying principle emerging from various judicial precedents is that enforceable accrual and credit to the payee are material conditions for attracting TDS liability.

Further, MSME interest possesses a statutory & compensatory character rather than a purely contractual one. While Section 23 of the MSMED Act disallows deduction of such interest under the IT Act, there is no specific provision clarifying whether TDS applies on mere book provisions where the liability has neither crystallized nor been claimed.

Accordingly, where:

(i) no demand for interest is raised by the MSME supplier;

(ii) liability is not finally determined or acknowledged;

(iii) no credit is made to the supplier's account; and

(iv) the amount is recognized only through a year-end provision for accounting purposes,

a reasonable view may be taken that Section 194A is not mandatorily attracted.

At the same time, in the absence of any direct judicial ruling specifically dealing with MSME interest provisions, divergent departmental interpretations cannot be ruled out. Consequently, many taxpayers adopt a conservative approach by deducting TDS to avoid potential exposure under Sections 201 and 40(a)(ia) of the IT Act.

 

AI Summary

TDS on MSME interest provisions may not arise where liability remains notional and uncredited to the supplier Deduction of tax at source under section 194A was considered for interest on delayed payments to MSME-registered suppliers where the interest was only recognised as a book provision and not actually demanded, credited, or paid. The discussion noted that TDS liability generally depends on an ascertained enforceable liability credited to an identifiable payee rather than a merely notional or contingent provision. Where no demand is raised, no final liability is determined, no credit is made to the supplier's account, and the amount is carried only as an accounting provision, section 194A may not be mandatorily triggered.