Section 43B(h) was introduced by the Finance Act, 2023, and is effective from the assessment year 2024-25. It aims to ensure timely payments to micro and small enterprises (MSEs) as per the stipulations of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. The objective of the new clause is to disallow, on an accrual basis, amounts payable to MSEs if such payments are not made within the timeline prescribed under Section 15 of the MSMED Act. This provision is a part of a larger policy push to support and strengthen the working capital and cash flow mechanisms for MSEs in India. It prevents businesses from unduly delaying payments to small vendors and contractors, which can otherwise significantly affect their financial health. The legislative intent is also clear: timely payment is not merely encouraged but enforced through a disallowance provision under the Income-tax Act, making it a matter of tax compliance rather than just commercial ethics.
Statutory Framework under MSMED Act
To understand Section 43B(h), one must also understand Section 15 of the MSMED Act. This section mandates that payments for supplies of goods or services to MSEs must be made within a maximum period of 45 days. Specifically, if the payment terms are agreed upon between the buyer and the MSE, payment must be made within the agreed timeline, which should not exceed 45 days. In the absence of such an agreement, the law requires payment within 15 days. Section 16 of the MSMED Act provides that any delay in making payment beyond this period requires the buyer to pay compound interest with monthly rests at three times the bank rate notified by the Reserve Bank of India. Section 23 states that such interest is not allowable as a deduction under the Income-tax Act. This legal framework sets the background for the introduction of clause (h) in Section 43B. Before this amendment, delayed payments were not specifically disallowed if paid before the due date of filing the return. Section 43B generally allowed certain expenses, such as taxes, duties, and contributionss, to be claimed as deductions only if they were paid. However, Section 43B(h) goes a step further by introducing a hard disallowance even if payment is made before the due date of filing the return, provided the delay exceeds the limits prescribed under Section 15 of the MSMED Act.
Overview of Form 3CD and Its Amendments
Form 3CD is an integral part of the tax audit report required under Section 44AB of the Income-tax Act. It serves as a detailed statement of particulars that must be furnished by the tax auditor during the audit of accounts. It contains various clauses that capture key elements of compliance under the Income-tax Act. Clause 26 of Form 3CD previously captured reporting requirements for disallowances under clauses (a) to (g) of Section 43B. These included disallowances related to contributions to welfare funds, interest on loans, and other similar items, based on actual payment. When Clause (h) was added to Section 43B by the Finance Act 2023, the Central Board of Direct Taxes issued Notification G.S.R. 155(E) dated 05-03-2024 to incorporate the new clause into Form 3CD. Specifically, the amendment updated Clause 26 to include a reference to Section 43B(h), suggesting that tax auditors must report on delayed payments to MSEs under this clause. However, the structure and language of Clause 26 were not aligned with the nature of the disallowance under Section 43B(h), which led to confusion and interpretational issues.
The Initial Ambiguity and Resulting Issues
The amendment to Clause 26 of Form 3CD by Notification G.S.R. 155(E) referenced Section 43B(h), but failed to specify any reporting mechanism for amounts payable to MSEs that were not paid within the due date as per the MSMED Act. Clause 26 was structured around the concept of disallowance being reversed if the amount was paid before the due date of filing the return under Section 139(1). However, Section 43B(h) introduced a stricter regime, under which the disallowance is triggered merely by breach of the payment timeline under Section 15 of the MSMED Act, irrespective of whether the amount was paid before the due date of return filing. Therefore, the continued use of Clause 26 for Section 43B(h) reporting was inconsistent with the statutory position. Further, Clause 26 required a detailed break-up and reporting of payment dates about the due date under Section 139(1). Applying such a structure to Section 43B(h) would mean that delayed payments which were otherwise made before the return filing due date would not be disallowed, which was contrary to the specific language of Section 43B(h). This misalignment led to the realization that a corrective action was necessary to ensure accurate and legally consistent reporting.
CBDT’s Corrigendum and the Corrective Realignment
To address this inconsistency, the CBDT issued a corrigendum to the earlier notification through Notification G.S.R. 223(E) dated 19-03-2024. This corrigendum made two critical changes. Firstly, it nullified the amendment made to Clause 26 through the earlier Notification G.S.R. 155(E). Secondly, it amended Clause 22 of Form 3CD to include a requirement to report disallowances under Section 43B(h). This corrigendum fundamentally realigned the reporting framework to reflect the distinct nature of Section 43B(h). Clause 22 of Form 3CD originally pertained to the reporting of interest payments on delayed payments to MSEs under Section 16 of the MSMED Act, which are disallowed under Section 23 of the MSMED Act. By including disallowances under Section 43B(h) within Clause 22, the corrigendum effectively consolidated all MSE-related disallowances into a single clause. This also provided clarity that Clause 26 would remain applicable only for clauses (a) to (g) of Section 43B, and not for clause (h).
Scope of Reporting Under the Amended Clause 22
Amended Clause 22 now requires the tax auditor to report two distinct elements. First, the amount of interest on delayed payments to MSEs under Section 16 of the MSMED Act, which continues to be disallowed under Section 23 of the MSMED Act. Second, the principal amounts payable to MSEs that are liable to be disallowed under Section 43B(h) for not being paid within the timelines of Section 15 of the MSMED Act. The amendment provides tax auditors with a clearer framework for compliance. Importantly, it recognizes that the disallowance under Section 43B(h) is based on the MSE payment timeline, and not linked to the date of filing the income tax return. Therefore, the reporting format in Clause 22 does not require payment dates vis-à-vis the return due date. It is sufficient to assess whether the due date under Section 15 of the MSMED Act has been breached. Another critical aspect of the revised Clause 22 is that the tax auditor must form an opinion on the disallowability of such payments. It is not enough to merely list delayed payments; the auditor must determine whether the conditions for disallowance under Section 43B(h) are met. This involves assessing whether the expenditure is otherwise allowable under the provisions of the Income-tax Act.
Determining Allowability and the Role of the Tax Auditor
A key requirement under Clause 22 is that only those amounts that are otherwise allowable under the Income-tax Act need to be reported for disallowance under Section 43B(h). Therefore, the tax auditor must examine whether the payments are not already disallowed under other provisions such as Explanation to Section 37(1), Section 40, or Section 40A. If any amount is disallowed under these other sections, then there is no need to report it again under Clause 22 for Section 43B(h) disallowance. The role of the auditor becomes critical in forming a professional opinion based on facts and documentation. The auditor must verify whether the supplier qualifies as a micro or small enterprise. This involves checking Udyam Registration details and ensuring that the enterprise status is valid as on the date of the transaction. Random checks may be required for suppliers who have transitioned from micro or small to medium enterprise status. According to the notification issued on 26-06-2020, a supplier who was classified as micro or small in the past shall continue to be treated as such for three years even if they subsequently graduate to medium. Auditors must ensure this transition rule is also appropriately applied while evaluating MSE status. The tax auditor should also ensure that the assessee has a system to identify its MSE vendors, preferably through a declaration or confirmation of Udyam Registration Number. These systems and controls form part of the audit documentation, nd also help assess the reliability of management’s claims regarding the payment status of MSE dues.
Payments by Cheques and Banking Verification
Where payments to MSE suppliers are made by cheque, the auditor should confirm that the cheque was not only issued but also handed over on or before the due date under Section 15 of the MSMED Act. Acknowledgements or proof of delivery of the cheque must be verified. The bank reconciliation statement must also be reviewed to identify any cheques issued but not presented for a long time. This may indicate that the supplier has not received the cheque in time, or that the cheque was not honoured within the stipulated time. It is important to note that payment is considered complete only when the MSE supplier receives the amount. Therefore, delays due to cheque dishonour or non-presentation will lead to a breach of the timeline under Section 15. If such delays exist, the auditor must consider these amounts for disallowance under Section 43B(h) and report them accordingly in Clause 22.
Timelines for Reporting and Applicability of Disallowance
The core test for disallowance under Section 43B(h) is whether the payment to a micro or small enterprise has been made within the prescribed time under Section 15 of the MSMED Act. This means that for each transaction with an MSE, the auditor must assess whether the due date as per the MSMED Act has been exceeded. If so, the amount becomes disallowable, irrespective of whether the actual payment occurred before the due date of filing the return under Section 139(1). The applicable dates under the MSMED Act vary depending on whether a written agreement exists. If there is a written agreement, the payment must be made within the agreed period, not exceeding 45 days. If there is no written agreement, the default statutory time limit is 15 days. These due dates are calculated from the date of acceptance or the deemed date of acceptance of the goods or services. The auditor should ensure that due dates are calculated accurately based on delivery records, invoices, purchase orders, and any service completion evidence. While the legislation does not mandate disclosure of each payment’s specific due date, the tax auditor must be satisfied that the disallowance reported in Clause 22 reflects non-compliance with the MSMED Act timelines.
Reporting Requirements for Outstanding Dues as of 31 March
A common question arises concerning amounts payable to MSEs that remain outstanding as of the end of the financial year. The position clarified through the corrigendum makes it clear that where such amounts are paid after 31 March but beyond the due date under Section 15 of the MSMED Act, the principal amount is to be reported in Clause 22 as disallowable under Section 43B(h). This applies even if payment is made before the due date of the income tax return. Therefore, two categories of outstanding amounts must be considered for reporting. The first category includes amounts that were already overdue as of 31 March. The second includes those that were not overdue as of 31 March but became overdue later due to payment being delayed beyond the post-balance-sheet due date under the MSMED Act. In both cases, if the delay breaches the time limit under the MSMED Act, disallowance under Section 43B(h) applies and must be reported in Clause 22. The interest component on these delayed payments must also be reported as inadmissible under Section 23 of the MSMED Act. The interest reporting obligation exists regardless of whether the interest is actually paid or merely accrued.
Clarification Regarding Payments Made Before 31 March
If the payment to an MSE has been made before 31 March, even if such payment occurred beyond the due date specified under the MSMED Act, the principal amount is not disallowed under Section 43B(h) since deduction on an actual payment basis is permissible. However, in such cases, the interest on delayed payments as per Section 16 of the MSMED Act still becomes inadmissible under Section 23. Therefore, such interest must be identified and reported separately under Clause 22. This distinction is essential. The principal amount paid after the MSMED Act’s due date but before year-end is not subject to disallowance under Section 43B(h), but the related interest continues to be inadmissible and reportable. The tax auditor should obtain schedules of payments to MSEs and identify which of these were delayed beyond MSMED due dates. Even where payment has been made before 31 March, if interest liability has arisen under the MSMED Act, and if that interest is debited to the profit and loss account, it must be disallowed and reported under Clause 22.
Taxpayer Following Cash Basis of Accounting
For taxpayers following the cash basis of accounting, Section 43B(h) has no application. This is because such taxpayers are allowed deductions only on actual payment, irrespective of the due date. As a result, the issue of disallowance on account of delayed payment does not arise under Section 43B(h) for them. However, even for such taxpayers, if interest on delayed payments to MSEs under Section 16 of the MSMED Act is paid and recorded in the books, such interest remains inadmissible under Section 23 of the MSMED Act. Therefore, the interest component must still be reported under Clause 22. Another compliance requirement exists under Section 22 of the MSMED Act, which mandates disclosures in the financial statements about the amount due to MSEs. This requirement applies irrespective of the accounting method and must be complied with in the notes to accounts. Hence, while Section 43B(h) disallowance is not applicable in a cash basis scenario, auditors must ensure proper disclosure under the MSMED Act and ensure that inadmissible interest is correctly identified and reported.
Verifying the MSE Status of Suppliers
An essential step in determining disallowance under Section 43B(h) is identifying whether the supplier qualifies as a micro or small enterprise. This determination must be based on valid Udyam Registration Certificates obtained under the MSMED Act. The tax auditor should verify whether the assessee has obtained Udyam declarations from suppliers or implemented any process for identifying MSE vendors. The Udyam Registration Number is typically mentioned on invoices. In addition to accepting the declaration or invoice markings, the auditor should perform random checks by verifying the Udyam status on the government portal using the registration number. In some cases, suppliers may have upgraded from micro or small to medium status. The law provides that such liers will continue to be treated as micro or small. The tax auditor should consider this continuity rule and not treat such suppliers as non-MSEs simply because their status has changed recently. This becomes especially important for larger assessees dealing with multiple vendors, where identifying current MSE status for all suppliers can be a challenge.
Disclosures and Auditor Responsibility
The tax auditor’s role extends beyond verifying due dates and supplier classifications. The auditor must document that management has a system in place for identifying MSE vendors, tracking due dates under the MSMED Act, and flagging any payment delays. Engagement letters for tax audit must include a clear statement indicating that it is the responsibility of management to comply with Chapter V of the MSMED Act and Section 43B(h) of the Income-tax Act. The letter should also state that it is the management’s responsibility to identify and obtain Udyam details from suppliers and verify them against official records. In case of statutory audits, the engagement letter or management representation letter should be updated to reflect these responsibilities. This becomes necessary as the reporting in Clause 22 is heavily dependent on correct vendor identification and the timing of payments. Where the auditor finds that such systems are not in place or the identification of MSE vendors is unreliable, appropriate disclosures or qualifications should be made in the audit report.
Due Dates and Calculation of Interest
Interest under Section 16 of the MSMED Act becomes payable where payment to the MSE is delayed beyond the time limit specified in Section 15. The interest is compounded monthly at three times the bank rate notified by the Reserve Bank of India. This interest is disallowed under Section 23 of the MSMED Act and must be reported in Clause 22. Calculation of this interest must be done carefully, particularly for long-overdue payments. The auditor should obtain a detailed computation from the assessee and verify its accuracy. Where the interest has not been recorded in the books, the auditor must consider whether any provision is required and assess the need for qualification in the audit report if no such provision is made. Even if the interest is not booked, the assessee’s liability to pay such interest under the MSMED Act exists by operation of law. Hence, the auditor should not rely solely on whether the assessee has accounted for it but must also apply professional judgment based on the facts of each case.
MSME-I Filing for Company Assessees
Companies that purchase goods or services from MSEs and have outstanding dues to such enterprises beyond the prescribed time must file Form MSME-I with the Ministry of Corporate Affairs. This filing is required on a half-yearly basis. The auditor should verify whether the company has filed this form for the relevant half-years and whether the amounts disclosed match those reported under Clause 22. Although this filing is under a different statute, consistency across disclosures is critical for ensuring the reliability of financial reporting and regulatory compliance. If discrepancies exist between amounts reported in Form MSME-I and Clause 22, the auditor should obtain explanations and take necessary steps for reconciliation. Where the filing has not been done, the auditor should evaluate whether this non-compliance has an impact on reporting obligations and whether additional disclosures or qualifications are required in the audit report.
Cheque Payments and Bank Reconciliation Checks
Where cheques are issued to MSE suppliers, it is not enough that the cheque was written before the due date. The cheque must also be handed over or dispatched to the supplier before or on the due date under the MSMED Act. The auditor must verify acknowledgements or dispatch proofs in such cases. Additionally, cheques should be account-payee only to ensure that the payment reaches the intended recipient. The bank reconciliation statement must be examined to identify whether any cheques issued to MSE suppliers have not been presented for a long time. Such items may indicate non-compliance with the MSMED Act’s payment timelines. In these cases, the auditor must carefully consider whether the amounts should be reported in Clause 22 for disallowance under Section 43B(h). The auditor must also ensure that stale cheques are not used as a method to defer payments to MSEs and avoid disallowance.
Delivery-Based Payment Tracking
Compliance with the MSMED Act’s payment timelines requires that payments be tracked on a delivery-wise basis. Each transaction involving the supply of goods or services must be evaluated individually to determine whether payment has been made within the prescribed period. The practice of calculating average due dates or making lump-sum payments covering multiple transactions does not satisfy the requirement under Section 15. The auditor must review purchase ledgers, invoices, and payment vouchers to ensure that delivery-wise compliance is being tracked. This can be especially challenging for large assessees with numerous transactions involving MSEs. In such cases, the auditor should test-check records, validate controls, and document findings in the audit file. Where the assessee uses ERP systems or accounting software, the auditor should verify whether the system allows tagging and tracking of MSE payments on an invoice-by-invoice basis. This system-based control can significantly reduce the risk of non-compliance and aid accurate reporting.
Capital Goods Payments and Their Treatment
Payments made to MSEs for the supply of capital goods are not typically covered by Section 43B(h) since such expenditures are not allowable as revenue expenditure. However, delays in such payments still attract interest under Section 16 of the MSMED Act. For assessees following the accrual basis of accounting, the interest payable on delayed payment for capital goods must be provided for and disallowed under Section 23. The auditor must ensure that such interest is identified and reported in Clause 22 even if the principal amount is not disallowed. Where no such provision is made, and the liability is certain, the auditor should consider whether the financial statements present a true and fair view. A disclosure or qualification may be required depending on the materiality of the interest amount.
Understanding the Reporting in Clause 26 of Form 3CD
Clause 26 of Form 3CD requires the tax auditor to report the amount of any liability incurred by the assessee during the previous year in respect of goods or services received from micro or small enterprises beyond the time limit specified in Section 15 of the MSMED Act, 2006. This clause has been modified to include specific reporting requirements under the newly inserted Section 43B(h). The intent is to identify amounts that are not allowable as deductions in the current year due to delayed payments to MSMEs.
The clause reads as follows: “In respect of any sum referred to in clause (h) of section 43B, please furnish the details of the amount which is not paid on or before the due date specified in the explanation to clause (h) of section 43B.”
This change aligns Clause 26 of Form 3CD with the amendment introduced through the Finance Act, 2023. It effectively seeks to bring consistency in disallowance provisions for MSME payments across income tax filings and tax audit reports. Auditors must now obtain the necessary details from the assessee regarding payments made to micro and small enterprises, including invoice date, due date as per the MSMED Act, actual payment date, and whether it falls within the permissible time limit.
Data Requirements for Accurate Reporting
For accurate reporting under Clause 26, the assessee must maintain and provide comprehensive data about transactions with MSME vendors. This includes:
- Vendor name and MSME registration number
- Nature of goods or services provided
- Date of receipt of goods or services
- Date of invoice
- Credit terms agreed upon (if any)
- Due date for payment as per Section 15 of the MSMED Act
- Actual date of payment
- Amount outstanding as on the balance sheet date
- Whether the payment is made within the prescribed limit (15 days if no agreement or within the number of days in the agreement, not exceeding 45 days)
The auditor must evaluate whether each payment is within the prescribed time frame and whether any disallowance arises under Section 43B(h). The auditor is also expected to test the completeness and accuracy of the data provided by the assessee. Verification of vendor classification as a micro or small enterprise is a critical part of this process, which can be supported by obtaining MSME registration certificates or declarations from the vendors.
Treatment in Computation of Income
The disallowance under Section 43B(h) impacts the computation of business income. Any payment to a micro or small enterprise that is not made within the time limit specified in Section 15 of the MSMED Act will be disallowed as an expenditure for that previous year. It will be allowed as a deduction only in the year in which the payment is made.
The computation of taxable income must therefore include an add-back of such delayed payments. The assessee must maintain a reconciliation of outstanding balances as on the balance sheet date andd identify amounts unpaid beyond the prescribed time limits to arrive at the correct disallowance figure.
It is important to note that Section 43B(h) overrides the method of accounting. Even if the assessee follows the mercantile system and has incurred the expense during the year, it will not be allowed unless paid within the prescribed time. This aligns the treatment with other clauses of Section 43B, such as those related to tax, duty, or PF contributions.
Role of Auditor in Ensuring Compliance
The auditor plays a pivotal role in ensuring compliance with Section 43B(h). While the primary responsibility of identifying MSME creditors and providing due dates rests with the assessee, the auditor must exercise professional judgment in verifying the classification and payment timelines.
The auditor should perform procedures such as:
- Verifying the list of vendors classified as MSMEs
- Reviewing supporting documentation for vendor classification (such as MSME registration)
- Testing a sample of transactions for accuracy of due date and payment date
- Evaluating the accounting treatment of delayed payments in the books
- Reviewing the computation of disallowance under Section 43B(h)
- Ensuring consistency between Form 3CD and tax return disclosures
In case of non-availability of vendor classification or missing documentation, the auditor should consider qualifying the report or including appropriate remarks. In certain cases, management representation may also be obtained regarding vendor classification and payment timelines, though it does not absolve the auditor of responsibility.
Timing of Deduction and Carry Forward of Disallowance
Payments disallowed under Section 43B(h) in a particular year will be allowed as deductions in the year in which the payment is made. There is no restriction on the carry forward of such disallowances, and they do not require any specific documentation apart from proper accounting entries and payment records.
For example, if an assessee makes a purchase from a registered MSME on January 10, 2025, and the agreement allows for a 30-day payment period, the payment must be made by February 9, 2025. If the payment is made on February 25, 2025, it falls beyond the 30-day limit. In such a case, the expense will be disallowed in the financial year 2024–25, and allowed as a deduction in 2025–26 when the payment is made.
Therefore, the assessee must keep a record of the year-wise disallowance and track subsequent payments to claim deductions in later years. The auditor should also cross-check disallowed amounts from earlier years to confirm whether those amounts are now eligible for deduction.
Documentation and Supporting Evidence
Both the assessee and the auditor must retain adequate documentation to support the classification of vendors, terms of supply, due dates, and payment records. Common documents include:
- MSME registration certificates
- Purchase orders and supply agreements
- Vendor declarations
- Invoices and goods received notes
- Payment vouchers and bank statements
- Reconciliation of outstanding balances
These records will not only facilitate compliance with Section 43B(h) but also assist in defending the treatment in case of tax scrutiny or litigation. The Income Tax Department may seek evidence to support the claim that the vendors are indeed micro or small enterprises and that the due dates were calculated correctly.
Given that the provisions of Section 43B(h) are new and may involve subjective judgments, maintaining a robust documentation trail is essential. Disputes may arise over whether a vendor qualifies as an MSME or whether the due date was correctly determined, especially in the absence of a written agreement.
Impact on Profit and Loss Account and Tax Return
The disallowance under Section 43B(h) affects the profit and loss account indirectly through adjustments made in the computation of income. While the expense may be debited to the profit and loss account based on accrual, the corresponding disallowance under Section 43B(h) must be added back in the tax computation.
The assessee must ensure that this adjustment is reflected in the income tax return under Schedule BP (Business or Profession) and the relevant disclosure is made in Form 3CD under Clause 26. The reconciliation of book profit and taxable profit should identify the disallowance to avoid any mismatch or inconsistency.
Taxpayers using ITR-3, ITR-5, or ITR-6, which apply to firms, LLPs, and companies, should ensure that the adjustment is properly disclosed. Errors or omissions in reporting may lead to penalty proceedings or adverse assessments.
Key Judicial Precedents and Interpretations
In the absence of specific litigation or judicial precedents on the newly inserted Section 43B(h), guidance can be drawn from interpretations of other clauses of Section 43B and similar compliance-based disallowance provisions. Courts have generally taken a strict view regarding tax compliance provisions linked with due dates or specific conditions. The Gujarat High Court in the case of CIT v. Gujarat Polycrete (P) Ltd. emphasized that statutory disallowances under Section 43B cannot be relaxed even if the assessee maintains books of account on the mercantile basis. Hence, it is expected that similar rigidity would be applied under Section 43B(h) in cases of non-payment to MSMEs within the time stipulated under the MSMED Act. While litigation on this specific clause will evolve, tax auditors and assessees must exercise caution and adopt conservative approaches during the initial years of implementation.
Auditor’s Role and Reporting Responsibility
The auditor’s responsibility in tax audit reporting under Clause 26 of Form 3CD, read with Section 43B(h), is to ensure accurate and fair representation of the disallowances arising due to delayed payments to MSMEs. This includes reviewing the entity’s vendor master to identify MSMEs, verifying registration certificates, checking the dates of invoice and actual payment, computing the time limits under the MSMED Act, and ensuring disallowance for unpaid dues as on 31 March. The auditor must also ensure that the client has not claimed any deduction in the profit and loss account for such unpaid dues. In case of misreporting or omission, the auditor could be held liable for professional misconduct under ICAI’s Code of Ethics and the Chartered Accountants Act, 1949. Therefore, proper documentation and working papers substantiating the auditor’s reporting are crucial.
Impact on Tax Liability and Advance Tax Computation
The disallowance under Section 43B(h) will directly affect the computation of taxable income. As such, businesses must consider this while calculating their advance tax liability. If the MSME dues are not paid within the specified time, the deduction will be disallowed in the current year, leading to an increase in taxable income and, consequently, the tax liability. Furthermore, since the disallowance applies irrespective of the method of accounting, companies adopting mercantile accounting must account for this carefully. Any failure to include this in advance tax computation could lead to interest under Sections 234B and 234C. This calls for enhanced coordination between the finance and tax departments within an organization to ensure timely compliance and avoid interest or penalties.
Deferred Deduction in Subsequent Years
Section 43B generally allows deduction in the year of actual payment if the conditions of the section are not fulfilled in the year of accrual. Similarly, if a payment to an MSME is disallowed under Section 43B(h) in the year of accrual due to delay beyond the MSMED Act’s time limit, the deduction can be claimed in the year of actual payment. However, this deferred deduction mechanism poses compliance challenges. The taxpayer must maintain accurate payment records and track when the deduction can be claimed. During assessments, the onus will be on the assessee to substantiate the timing of payment to MSMEs and justify the claim of deduction in the later year. Also, if the disallowance results in MAT (Minimum Alternate Tax) credit mismatches, further reconciliation complexities could arise.
MSME Classification and Practical Issues
Identifying MSME vendors and their correct classification under the MSMED Act is a practical challenge. Many vendors may not have updated their Udyam Registration status or may fail to furnish the necessary certificate. Moreover, the dynamic nature of MSME classification—dependent on investment and turnover—can lead to vendors shifting in and out of MSME status year-on-year. To ensure proper compliance, businesses must collect Udyam Registration Certificates and declarations at regular intervals and update their ERP systems accordingly. If a vendor has not furnished the required registration, the assessee may reasonably conclude that the entity is not covered under the MSMED Act, thereby avoiding disallowance under Section 43B(h). However, this reasoning must be backed by documentation and due diligence.
Record-Keeping and Documentation
Accurate record-keeping is central to complying with Section 43B(h). The assessee must maintain the following records: 1) MSME vendor list with Udyam Registration details; 2) Copies of registration certificates; 3) Purchase invoices with dates of acceptance; 4) Payment records with bank statements or digital payment proofs; 5) Computation of the 15/45-day period under the MSMED Act; and 6) Reconciliation statements showing unpaid dues as on 31 March and amount disallowed under Section 43B(h). These records must be reviewed and maintained year-over-year, as they will be critical during tax audits and departmental assessments. Lack of supporting evidence could lead to an addition to income and unnecessary litigation.
Coordination Between Accounts, Tax, and Legal Teams
The successful implementation of Section 43B(h) requires coordination between multiple departments within an organization. The accounts team must ensure timely payment tracking; the legal/compliance team must validate MSME status and contractual terms; and the tax team must ensure proper reporting and disallowance where applicable. A centralized compliance mechanism, possibly driven by ERP alerts or automated tracking systems, can significantly reduce the risk of inadvertent disallowance. Communication with vendors is also key—companies should request MSME declarations and proactively resolve disputes that could delay payments and lead to disallowance.
Recommendations and Actionable Steps for Businesses
Businesses should adopt the following action plan to ensure compliance with Section 43B(h): 1) Identify all MSME vendors and collect Udyam Registration Certificates; 2) Update ERP/vendor master data to flag MSME vendors; 3) Integrate payment due date tracking with MSME timelines (15/45 days); 4) Implement regular internal reviews to detect unpaid MSME dues as on 31 March; 5) Train accounting and tax staff about implications of Section 43B(h); 6) Maintain robust documentation for audit trail; 7) Ensure reporting under Clause 26 of Form 3CD is accurate and complete; 8) Monitor changes in vendor classification and update records accordingly. These measures will help mitigate disallowance risk, avoid interest/penalties, and ensure smooth tax audits.
Conclusion
Section 43B(h) marks a significant policy intervention by linking income-tax deductions with the timely payment obligations under the MSMED Act. While it aims to support MSMEs and foster prompt payments, it brings about increased compliance obligations for businesses. The tax audit process under Clause 26 of Form 3CD must now incorporate additional checks, validations, and disclosures. Given the possibility of tax disallowance, penalty exposure, and reputational risk, businesses must prioritize MSME compliance as part of their overall tax risk management strategy. Early adoption of robust systems and periodic compliance reviews will ensure that the impact of this provision is managed effectively and proactively.