Section 43B(h): MSME Payment Compliance for Businesses

The Finance Act 2023 introduced a significant amendment that has changed how businesses manage payments to their MSME vendors. Section 43B(h) of the Income Tax Act now disallows deductions for payments to Micro and Small Enterprises if they are not made within the prescribed time limit.

This is one of the most impactful compliance changes for businesses with MSME suppliers — and non-compliance can result in a substantially higher tax liability.

Section 43B of the Income Tax Act lists certain expenses that are deductible only on actual payment (not on accrual basis). The Finance Act 2023 added clause (h), which states:

In simple terms: if you owe money to an MSME vendor and don't pay within the prescribed time, you cannot claim that expense as a deduction in the current year — even if you've accounted for it in your books.

Section 43B(h) applies to:

• All businesses (companies, LLPs, partnerships, proprietorships) that compute income under Profits and Gains of Business or Profession
• Payments made to Micro Enterprises and Small Enterprises registered under the MSMED Act (Udyam Registration)

Important: It does not apply to Medium Enterprises or large businesses — only Micro and Small.

The MSMED Act, 2006 (Section 15) prescribes:

• If there is a written agreement: Payment must be made within the agreed period, subject to a maximum of 45 days
• If there is no written agreement: Payment must be made within 15 days of acceptance of goods/services

Key point: Even if your contract with an MSME vendor says "60 days credit," the law caps it at 45 days. Any payment beyond 45 days is treated as delayed.

If you fail to pay an MSME vendor within the prescribed time:

1. The expense is disallowed in the year it was accrued
2. It becomes deductible only in the year of actual payment
3. This effectively increases your taxable income for the year of accrual

Example:

• You purchase goods worth ₹50 lakh from an MSME vendor in March 2026
• Payment is due by April 15, 2026 (45 days)
• You pay in June 2026 (after the ITR filing deadline)
• The ₹50 lakh expense is disallowed in FY 2025-26 and deductible only in FY 2026-27

For a company in the 25% tax bracket, this means paying ₹12.5 lakh in additional tax for FY 2025-26 — even though the expense is genuine.

The key challenge is knowing which of your vendors are registered MSMEs. Here's how:

1. Ask vendors directly for their Udyam Registration Number
2. Verify on the Udyam portal: udyamregistration.gov.in
3. Update your vendor master with MSME status and registration category (Micro/Small/Medium)

Note: Only Micro and Small enterprises trigger Section 43B(h). Medium enterprises are excluded.

Identify all vendors who are Micro or Small enterprises. Collect and verify their Udyam Registration certificates.

Review all purchase agreements with MSME vendors. Ensure payment terms do not exceed 45 days — any clause beyond 45 days is legally unenforceable and creates a tax risk.

Implement a system to track invoice dates and payment due dates for MSME vendors separately. ERP systems should flag MSME invoices approaching the 45-day limit.

Before closing your books for the financial year, identify all outstanding MSME payables older than 45 days. Either make the payment before March 31 or account for the disallowance in your tax computation.

If you are subject to tax audit under Section 44AB, your auditor will report MSME payment delays in Form 3CD. Ensure your records are accurate.

The Ministry of Corporate Affairs (MCA) requires companies to disclose MSME outstanding balances in their financial statements under Schedule III. This includes:

• Amount due to MSMEs outstanding for more than 45 days
• Interest payable under the MSMED Act (18% p.a. compound interest on delayed payments)

Beyond the income tax disallowance, the MSMED Act itself imposes compound interest at 3 times the RBI bank rate (currently approximately 18% p.a.) on delayed payments. This interest is:

• Payable to the MSME vendor
• Not deductible as a business expense under Section 23 of the MSMED Act

• Section 43B(h) applies from AY 2024-25 onwards (FY 2023-24 onwards)
• Payments to Micro and Small enterprises must be made within 45 days (or 15 days if no agreement)
• Delayed payments result in expense disallowance in the year of accrual
• Identify your MSME vendors now and update payment processes accordingly

Our tax compliance team helps businesses:

• Identify MSME vendors and verify Udyam registrations
• Review purchase agreements for 43B(h) compliance
• Compute year-end disallowances accurately
• Advise on payment scheduling to avoid tax impact

Contact us at [email protected] or WhatsApp +91 92172 31472.

Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified CA for advice specific to your situation.