Table of Contents
Introduction: Why Timely MSME Payments Are Now a Tax Priority
The Micro, Small, and Medium Enterprises (MSME) sector is the backbone of India’s economic framework, contributing to employment, innovation, and GDP growth. Recognizing the financial vulnerability of these enterprises, the Indian government has taken multiple legislative steps to ensure timely payments to MSMEs.
Among these, a critical provision introduced through the Finance Act, 2023, has significantly reshaped tax compliance dynamics—Section 43B(h) of the Income Tax Act, 1961. Effective from 1st April 2023 (FY 2023-24), it mandates that buyers must clear dues to MSMEs within the stipulated timeline; failure to do so results in disallowance of such expenses for income tax computation purposes.
This article provides a comprehensive legal analysis, procedural clarity, and a tax expert’s perspective on how to manage MSME liabilities and ensure smooth compliance before 31st March 2025, the closing of FY 2024-25.
Legislative Framework Governing MSME Payments
1. Micro, Small and Medium Enterprises Development (MSMED) Act, 2006
The MSMED Act lays down the rules for payment terms between buyers and MSMEs.
Section 15 of the MSMED Act, 2006:
This section obliges buyers to make payments to MSMEs within:
- 15 days from the date of acceptance or deemed acceptance of goods/services if no agreement exists.
- A maximum of 45 days, if an agreement exists.
⚖️ Legal Note: As per Section 2(b) of the MSMED Act, “appointed day” means the day immediately following the expiry of the period of fifteen days from the day of acceptance or deemed acceptance of any goods or services.
Non-compliance with these time limits can trigger interest liabilities under Section 16 of the MSMED Act.
2. Section 43B(h) of the Income Tax Act, 1961 – Newly Inserted via Finance Act, 2023
Text of the Provision:
“Any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in Section 15 of the MSMED Act, 2006, shall be allowed as a deduction only in the year in which the payment is actually made.”
Key Highlights:
- Applies to Micro and Small Enterprises only, as per the definition in the MSMED Act.
- Medium enterprises are not covered.
- This clause overrides Section 36(1) or any other provision permitting accrual-based deduction.
- If payment is not made within the permitted time frame (15 or 45 days), it is disallowed as an expense under the Profit & Loss Account for that year.
- Deduction can be claimed only in the year when actual payment is made.
Practical Impact of Section 43B(h) on Taxpayers
The amendment changes the long-standing accrual-based deduction method to a strict payment-based deduction, specifically for dues owed to Micro and Small Enterprises. Here’s how non-compliance impacts businesses:
1. Disallowance of Business Expense:
If the payment due to an MSME is not made within the statutory time frame (15 or 45 days), it will be disallowed u/s 43B(h) while computing business income.
2. Increase in Taxable Income:
The disallowed expense is added back to the total income, increasing the taxable profits, thereby leading to higher tax outflow.
3. Timing Difference in Deduction:
Businesses can only claim the deduction in the year of actual payment, which can lead to a mismatch in revenue and expense recognition.
4. Scrutiny Exposure:
Non-compliance may trigger scrutiny by tax authorities, especially if there are substantial outstanding balances to MSMEs in Form 3CD (Tax Audit Report).
Applicability and Coverage
Particulars | Applicability |
Applicable From | FY 2023-24 (AY 2024-25) |
Applies To | All assessees (Companies, Firms, Individuals) |
Enterprises Covered | Micro and Small only (not Medium) |
Basis of Classification | Udyam Registration under MSMED Act |
Deduction Allowed On | Actual Payment (if beyond 15/45 days) |
Disallowance Under | Section 43B(h) |
Classification of MSMEs as Per Latest Criteria
Classification | Investment in Plant & Machinery | Annual Turnover |
Micro | ≤ ₹1 crore | ≤ ₹5 crore |
Small | ≤ ₹10 crore | ≤ ₹50 crore |
📌 Note: These classifications are based on Udyam Registration. Buyers must maintain documentary evidence (Udyam Certificate) for tax purposes.
Key Compliances to Be Completed Before 31st March 2025
Step 1: Identify MSME Vendors
- Obtain and verify Udyam Registration Number or MSME Certificate.
- Maintain a list of all vendors falling under Micro or Small categories.
Step 2: Review Agreement and Payment Terms
- Scrutinize each vendor agreement to identify the agreed payment period.
- If no agreement exists, assume the statutory limit of 15 days.
Step 3: Review Ledger and Outstanding Balances
- Extract an ageing report of outstanding balances as of 15th March 2025.
- Identify dues pending beyond the permissible limit.
Step 4: Make Payments Before 31st March 2025
- Prioritize clearing such dues to claim deduction in FY 2024-25 itself.
- Payments made after 31st March will only be deductible in the year of payment.
Step 5: Maintain Documentation
- Keep proofs of payment (bank entries, NEFT/RTGS), invoices, and agreements.
- This will serve as evidence in case of income tax scrutiny.
Step 6: Disclose in Tax Audit Report
- In Form 3CD, disclose disallowance under Clause 21(h) relating to Section 43B.
- Auditor must report unpaid dues to MSMEs which exceed the time limit.
Case Law Analysis and Judicial Perspective on Section 43B(h) and MSMED Act
As Section 43B(h) is a recent amendment introduced by the Finance Act, 2023, there are currently no direct judicial precedents interpreting this specific clause. However, to understand the judicial perspective, we can draw on a combined reading of established judgments under:
- Section 43B (other clauses),
- Section 15–16 of the MSMED Act, 2006, and
- The general judicial approach to statutory disallowances, mandatory deductions, and overriding provisions.
1. Legislative Intent Behind Section 43B(h)
Section 43B was originally introduced to prevent the abuse of mercantile accounting, where taxpayers claimed deductions for liabilities they had not paid. The insertion of clause (h) furthers this objective, ensuring that timely payments are made to Micro and Small Enterprises, as envisaged under Section 15 of the MSMED Act, 2006.
Judiciary has consistently held that the intention of Section 43B is to ensure actual cash outflow before claiming deductions, which makes Section 43B(h) a natural extension of this principle—now tailored toward protecting small enterprises.
2. Relevant Judgments on MSME Payment Timelines (Before Section 43B(h))
While there are no specific judgments on Section 43B(h), Indian courts have previously addressed the binding nature of payment timelines under the MSMED Act. The following judgments provide valuable insight:
⚖️ M/s. P.K. Agencies v. Union of India (2021)
- Citation: (2021) SCC Online Del 4690
- Key Finding: The Delhi High Court held that payment deadlines under Section 15 of the MSMED Act are mandatory, and interest under Section 16 is automatic and not subject to any separate agreement.
Relevance: This reinforces that failure to pay within the specified MSMED period attracts statutory consequences—a position now embedded in the income tax law via Section 43B(h).
3. Supreme Court on the Overriding Nature of MSMED Act
⚖️ Principal Chief Engineer v. Manibhai and Bros. (Sleeper) (2022)
- Citation: (2022) 2 SCC 608
- Key Finding: The Hon’ble Supreme Court held that remedies under the MSMED Act prevail over other contractual and statutory remedies due to its beneficial and overriding nature.
Relevance: This principle is crucial in interpreting Section 43B(h), as it confirms that compliance with the MSMED Act is not optional, and thus, disallowance under the Income Tax Act aligns with this legal doctrine.
FAQ on Section 43B(h) – MSME Payment Disallowance
1. What is Section 43B(h) of the Income Tax Act, 1961?
Answer: Section 43B(h) was introduced by the Finance Act, 2023, effective from April 1, 2024 (Assessment Year 2024–25). It stipulates that any sum payable by an assessee to a Micro or Small Enterprise (MSE) for goods or services will be allowed as a deduction only if the payment is made within the time limits specified under Section 15 of the MSMED Act, 2006. If the payment exceeds these timelines, the expense will be allowed as a deduction only in the year of actual payment.
2. To whom does Section 43B(h) apply?
Answer: This provision applies to all assessees (individuals, firms, companies, etc.) who have outstanding payments to Micro or Small Enterprises registered under the MSMED Act, 2006. It does not apply to payments made to Medium Enterprises or unregistered entities.
3. What are the payment timelines under Section 15 of the MSMED Act, 2006?
Answer: Section 15 mandates that payments to MSEs must be made:
- Within 15 days from the date of acceptance or deemed acceptance of goods or services, if there is no written agreement.
- Within the agreed period in writing, which cannot exceed 45 days from the date of acceptance or deemed acceptance.
Failure to adhere to these timelines results in the disallowance of the expense under Section 43B(h).
4. Does Section 43B(h) apply to Medium Enterprises?
Answer: No, Section 43B(h) specifically applies only to Micro and Small Enterprises as defined under the MSMED Act, 2006. Payments to Medium Enterprises are not covered under this provision.
5. Is Udyam Registration mandatory for a supplier to be considered an MSE under Section 43B(h)?
Answer: Yes, for a supplier to be recognized as a Micro or Small Enterprise under the MSMED Act, 2006, and consequently for Section 43B(h) to apply, the supplier must have a valid Udyam Registration. Without this registration, the provisions of Section 43B(h) do not apply.
6. Does Section 43B(h) apply to capital expenditures?
Answer: No, Section 43B(h) applies only to revenue expenditures that are otherwise allowable as deductions under the Income Tax Act. Capital expenditures, which are not deductible under the Act, are not subject to disallowance under this section.
7. If payment is made after the due date but before filing the income tax return, is the expense deductible?
Answer: No, the first proviso to Section 43B, which allows deductions for payments made before the due date of filing the return, does not apply to payments covered under Section 43B(h). Therefore, if the payment to an MSE is made after the specified timeline under the MSMED Act, the expense is deductible only in the year of actual payment, regardless of when the return is filed.
8. Does Section 43B(h) apply to payments to traders registered under the MSMED Act?
Answer: As per the Office Memorandum No. 5/2(2)/2021-E/P and G/Policy dated July 2, 2021, wholesale and retail traders are eligible for Udyam Registration only for the purpose of availing Priority Sector Lending benefits. Therefore, payments to such traders are not covered under Section 15 of the MSMED Act, and consequently, Section 43B(h) does not apply to them.
9. Is the entire amount payable, including GST, subject to disallowance under Section 43B(h)?
Answer: Yes, Section 43B(h) refers to “any sum payable,” which includes the total amount payable to the MSE, encompassing the principal amount and any applicable taxes such as GST. Therefore, the entire outstanding amount is subject to disallowance if not paid within the specified timeline.
10. What happens if the payment is made within the same financial year but beyond the specified timeline?
Answer: If the payment to the MSE is made after the specified timeline under Section 15 of the MSMED Act but before the end of the financial year, the expense is still allowed under Section 43B(h) for that year. It becomes deductible in the year of actual payment hence the year is same.
11. Are there any interest implications under the MSMED Act for delayed payments?
Answer: Yes, under Section 16 of the MSMED Act, if a buyer fails to make payment to an MSE within the specified timeline, they are liable to pay compound interest with monthly rests at three times the bank rate notified by the Reserve Bank of India. This interest is in addition to the disallowance under Section 43B(h).
12. How should businesses ensure compliance with Section 43B(h)?
Answer: To ensure compliance:
- Identify all suppliers who are registered as Micro or Small Enterprises under the MSMED Act.
- Review payment terms and ensure that payments are made within the stipulated timelines (15 or 45 days).
- Maintain proper documentation, including Udyam Registration certificates, invoices, and payment records.
- Regularly monitor outstanding dues to MSEs to avoid disallowance of expenses and interest liabilities.
Other Practical Considerations for Businesses
✔Automation of Payables:
Invest in accounting software to generate alerts for due dates based on MSMED timelines.
✔ Vendor Onboarding SOPs:
Incorporate MSME status check during vendor onboarding and agreement drafting.
✔Audit Readiness:
Ensure documentation is updated with MSME registration, agreement copies, and evidence of payment timelines.
Important Circulars & Notifications to Refer
- Notification No. S.O. 2119(E), dated 26th June 2020: Defines revised MSME classification.
- CBDT Circular No. 01/2024, Dated 03.01.2024 (if issued, subject to verification) – May clarify application of Section 43B(h) in case of disputes.
Conclusion: Timely MSME Payments – A Strategic Compliance Imperative
As the financial year draws to a close, the significance of timely payments to MSMEs cannot be overstated. Section 43B(h) of the Income Tax Act, 1961—effective from FY 2023–24—is not merely a tax provision; it is a legislative push toward responsible and ethical business practices. Failing to adhere to these timelines may result in serious tax disallowances, inflated profits, and avoidable tax burdens, besides risking credibility with suppliers and scrutiny from tax authorities.
Organizations must act now—identify MSME creditors, verify registration status, prioritize clearing dues, and maintain proper documentation. Tax planning isn’t just about deductions; it’s about smart compliance and foresight. Remember, payments made after 31st March for invoices due till 15th March will lead to disallowance, potentially escalating your income tax liability for the year.
For startups, SMEs, corporates, accountants, and tax professionals, this is a pivotal compliance area that deserves top attention before closing the books of accounts for FY 2024–25. Avoid the rush, plan wisely, and protect your tax deductions by acting before it’s too late.
👉 Timely compliance isn’t just a regulatory necessity—it’s a business advantage.
For more updates on income tax law, GST, MSME compliance, and expert insights on how to manage your tax risks smartly – Follow TaxGroww – your trusted partner in accurate tax compliance, audit-readiness, and proactive planning.