Section 43B(h) of the Income Tax Act: MSME 45-day payment rule, disallowance triggers, and the operational reset every Indian buyer must complete

Abstract

The Finance Act, 2023 inserted Section 43B(h) into the Income Tax Act, 1961, effective from Financial Year 2023-24 (Assessment Year 2024-25). The provision disallows any sum payable by a buyer to a Micro or Small Enterprise (MSE) beyond the 45-day window prescribed under Section 15 of the MSMED Act, 2006. The disallowance operates on a paid-basis test, the buyer cannot claim the expense for income tax purposes in the year of accrual unless the MSE supplier has been paid within the statutory window. Where the payment is made in a subsequent year, the deduction is claimable in that subsequent year. Section 43B(h) has materially reshaped vendor payment behaviour across Indian businesses, creating a new working-capital discipline focused on MSE suppliers specifically. This article walks through the legislative framework, the operational scope and exemptions, the AY 2024-25 reporting requirements in Form 3CD and the Indian GAAP impact, a vendor classification methodology, and the operational reset every Indian buyer must complete before the 31 October tax audit cycle.

Related: Tax Audit Services · MSME / Udyam Registration · Income Tax Return Filing

Introduction

For most of the post-2006 history of the Micro, Small and Medium Enterprises Development Act (MSMED Act), the 45-day payment rule under Section 15 was widely understood but inconsistently enforced. The Act provides for compound interest at three times the bank rate where payment exceeds 45 days, and a dispute-resolution mechanism through the Micro and Small Enterprise Facilitation Council (MSEFC) at the state level. In practice, the interest claim was rarely litigated and MSEFC proceedings were sporadic. The result was that large buyers stretched MSME payment cycles to 60, 90, even 120 days as a working-capital tool.

The Finance Act, 2023 changed this calculus by introducing Section 43B(h) of the Income Tax Act. The new provision converts the MSMED 45-day payment rule into an income-tax compliance obligation. A buyer who pays an MSE supplier beyond 45 days cannot claim the corresponding expense for income tax purposes until the MSE is actually paid. The disallowance is computed at the buyer's effective tax rate and applied year-on-year, with a paid-basis catch-up in the year of actual payment.

The financial impact is material. For a buyer in the 25.17 percent corporate tax bracket, a delayed payment of ₹10 lakh to an MSE supplier carries a tax cost of ₹2.51 lakh in the year of accrual if the payment is not made within 45 days. The amount is recoverable in the year of payment, but the buyer faces a permanent timing disadvantage and an interest cost on the delayed cash outflow. For buyers with vendor concentrations heavily skewed toward MSE suppliers, manufacturing, e-commerce, consumer goods, Section 43B(h) is the single largest change in working-capital accounting since the introduction of GST.

This article walks through the operational and compliance reset that every Indian buyer must complete in light of Section 43B(h).

Related: Statutory Audit · MCA Compliance · GST Returns

The legislative framework

The text of Section 43B(h) reads, in substance, that 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 deduction only in the previous year in which such sum is actually paid by the assessee, irrespective of the previous year in which the liability to pay was incurred by the assessee according to the method of accounting regularly employed by him.

Three legislative elements are foundational.

Element 1: MSME classification under the MSMED Act, 2006. The MSMED Act defines three categories, Micro, Small, and Medium, based on investment in plant and machinery (for manufacturers) or in equipment (for service providers), and turnover. The classification is administered through the Udyam Registration portal. Importantly, Section 43B(h) applies only to Micro and Small Enterprises, Medium Enterprises are outside the scope.

Element 2: Section 15 of MSMED Act, 2006, the 45-day payment rule. Section 15 reads: "Where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day. Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance." The "appointed day" is defined as the day immediately following the expiry of fifteen days from the day of acceptance or deemed acceptance.

Element 3: Section 16 of MSMED Act, interest on delayed payment. Where the buyer fails to pay within the agreed period (or 45 days max, or 15 days default), the buyer is liable to pay compound interest with monthly rests to the supplier at three times the bank rate notified by the Reserve Bank of India. The interest under Section 16 is not deductible under Section 23 of the MSMED Act for the buyer's income tax purposes, a separate disallowance from Section 43B(h).

The combined effect: a buyer who pays an MSE beyond 45 days faces both the Section 43B(h) deduction deferral and the Section 16 interest liability with the Section 23 disallowance of that interest.

Related: Tax Audit under Section 44AB · Transfer Pricing

Scope, exemptions, and edge cases

Who is covered

Section 43B(h) applies to every "assessee" under the Income Tax Act who has a payable to a Micro or Small Enterprise. This includes companies, LLPs, partnership firms, sole proprietors, and HUFs. It applies regardless of the buyer's own size, a small buyer with an MSE supplier is equally caught.

What is covered

Any "sum payable" to a Micro or Small Enterprise for supply of goods or services. This includes payments for:

• Goods purchased (raw materials, finished goods, capital goods)
• Services received (professional services, contract manufacturing, transportation, AMC, repairs)
• Reimbursements where the underlying supply is from an MSE

What is not covered

• Payments to traders, where the trader is not the actual manufacturer or service provider of the supply.
• Payments to Medium Enterprises (only Micro and Small are within scope).
• Payments to unregistered MSMEs (Udyam Registration is a precondition; an MSE without Udyam Registration is not "an MSE" for Section 43B(h) purposes, though it may still be a Micro or Small enterprise under the MSMED Act for interest claims).
• Payments by entities not subject to the Income Tax Act's deduction rules (e.g., charitable trusts under Section 11/12).

Edge cases

Advance payment. Where the buyer pays in advance before the supply, Section 43B(h) does not trigger because there is no "sum payable" outstanding. The expense is claimed when the supply is recognised.

Credit notes. Where a vendor issues a credit note reducing the payable, the credit note amount is netted against the payable for the 43B(h) test.

Disputed amounts. Where the buyer disputes part of the invoice and withholds that portion in good faith, the disputed portion is arguably outside the 43B(h) trigger because the "sum payable" is contested. However, conservative practice is to disclose the dispute in the tax audit report and document the dispute through written correspondence with the supplier.

Year-end accruals. Where the buyer accrues an expense at year-end without an invoice, the 45-day clock runs from the day of acceptance of supply (or deemed acceptance under Section 2(b) of MSMED Act). Conservative practice is to require invoice within the year-end to avoid 43B(h) trigger on accrued but un-invoiced supplies.

AY 2024-25 reporting in Form 3CD

The tax audit report under Section 44AB (Form 3CD) for AY 2024-25 has new reporting columns specifically for Section 43B(h).

Clause 22 of Form 3CD has been amended to require reporting of:

• Total amount payable to MSEs outstanding at year-end
• Amount paid within the prescribed period
• Amount paid beyond the prescribed period
• Amount unpaid at year-end (disallowed for the year)

The auditor verifies these disclosures against:

• The buyer's accounts payable ageing
• Udyam Registration certificates collected from suppliers
• The buyer's vendor master with MSME classification flags
• Payment records and bank statements

A common audit qualification we now flag is a buyer's failure to obtain Udyam certificates from suppliers, leaving the MSME classification status unverified. In such cases, the auditor reports the amount as "MSME status not verified", which is not a disallowance per se but raises a flag for the Income Tax Department.

Related: Tax Audit Services · Annual ROC Filing

The vendor classification framework

The single highest-leverage action for any Indian buyer is to set up a clean MSME vendor classification framework. KAMRIT recommends the following workflow.

Step 1: Onboarding documentation. At vendor onboarding, the buyer must obtain:

• Udyam Registration Certificate (mandatory)
• PAN and GSTIN of the vendor
• Bank account details for payment
• Written agreement on payment terms (limited to maximum 45 days for MSEs)

If a vendor cannot produce a Udyam Registration Certificate, the buyer should treat the vendor as a non-MSE for record-keeping purposes, but be aware that this is a compliance risk. A non-Udyam-registered enterprise can still be a Micro or Small enterprise under the MSMED Act and can claim Section 16 interest. The protective position is to obtain Udyam status confirmation in writing as part of onboarding.

Step 2: Vendor master tagging. The buyer's ERP or accounting system should carry an MSME classification flag for every vendor, Micro, Small, Medium, or Non-MSME. The flag should drive:

• Payment terms (limited to 45 days for Micro and Small)
• Accounts payable ageing buckets (MSE buckets are 0-15, 15-45, 45-day overdue, year-end overdue)
• Year-end disclosures in Form 3CD

Step 3: Quarterly Udyam re-verification. Udyam classification can change when a vendor's investment in plant or turnover crosses the thresholds. The buyer should re-verify Udyam status quarterly to catch re-classifications.

Step 4: Payment cycle reset to net-45 maximum for MSEs. The buyer's procurement and finance teams must agree that every MSE supplier is paid within 45 days of acceptance, with no exception. The cash-flow tool of stretching MSE payments is gone, the tax cost more than offsets the working-capital benefit at any tax rate above 18 percent.

Step 5: Disputed-payment escalation protocol. Where a payment is genuinely disputed and the buyer needs to withhold beyond 45 days, the dispute must be documented in writing to the supplier, escalated to the management committee within 30 days of acceptance, and disclosed in the tax audit report. Conservative practice is to pay the undisputed portion and withhold only the disputed amount.

Sectoral and operational implications

The implications of Section 43B(h) vary by sector based on vendor concentration toward MSEs.

Manufacturing. Most contract manufacturers, component suppliers, and packaging vendors in India are MSEs. A typical mid-sized Indian manufacturer has 60-80 percent of its vendor spend with MSE suppliers. Section 43B(h) is a material working-capital and tax-planning event. KAMRIT clients in this segment have reset payment cycles from net-60 or net-90 to net-45 as a board-level priority.

E-commerce. D2C brands relying on contract manufacturers, packaging vendors, and logistics partners face the same concentration. The added complication is that e-commerce buyers often pay through marketplace settlement cycles that exceed 45 days, requiring re-engineering of the cash-flow chain.

Consumer goods. Both manufacturing and distribution chains have substantial MSE exposure. The impact on private-label brands and contract-manufacturer-dependent brands is acute.

SaaS and IT services. Lower MSE exposure as most input services are professional services from larger entities. However, contract development, freelancer payments, and small-firm vendor relationships still trigger.

Real estate and construction. Substantial exposure through sub-contractors, equipment hire, and material suppliers. Most general contractors fall within MSE definition.

The 31 October tax-audit-cycle action plan

For any Indian business approaching the 31 October tax audit filing for AY 2024-25 or AY 2025-26, the following action plan must be completed.

1. MSE vendor identification. Identify every vendor with Udyam Registration as Micro or Small.
2. Ageing analysis. Run an MSE-specific accounts payable ageing as of 31 March of the relevant year. Bucket: 0-45 days, 45-day overdue, year-end overdue.
3. Disallowance quantification. For year-end overdue MSE payables, compute the disallowance at the buyer's effective tax rate.
4. Form 3CD Clause 22 disclosure. Populate the new Clause 22 disclosures with verified data.
5. Auditor walkthrough. Walk the auditor through the vendor classification framework and the payment ageing methodology. Be prepared to defend any "MSME status not verified" entries.
6. Year-on-year reconciliation. Where prior-year disallowances become deductible due to FY 2024-25 payment, claim the corresponding deduction in the current year's computation.
7. Vendor communication. Communicate the buyer's MSE 45-day payment policy in writing to top 20 MSE vendors. This is a defensive document for both Section 43B(h) and Section 16 MSMED Act litigation risk.

References

1. Finance Act, 2023, insertion of Section 43B(h) into Income Tax Act, 1961.
2. Micro, Small and Medium Enterprises Development Act, 2006, Sections 15, 16, 23.
3. Udyam Registration portal, https://udyamregistration.gov.in
4. CBDT Circular on Section 43B(h) reporting in Form 3CD (issued for AY 2024-25 reporting).
5. Income Tax Act, 1961, Section 44AB and Form 3CD Clause 22 (amended).