Section 43B MSME Payment Disallowance Under New Act: Notice Triggers, Response Strategy & Penalties

The Core Rule — Section 43B(h) in Plain English

Section 43B(h) adds a specific deductibility condition for amounts payable to Micro and Small Enterprises:

• Without written agreement: Payment must be made within 15 days of delivery of goods or completion of service
• With written agreement: Payment must be made within the period specified in the agreement, but not exceeding 45 days from delivery/completion. Even if the agreement says 60 days, 45 days is the maximum enforceable limit
• If unpaid at 31 March: The outstanding amount is disallowed as a deduction in that financial year and becomes deductible only in the year of actual payment

Which Vendors Are Covered — Micro and Small Only

Verify MSME status of all vendors at udyamregistration.gov.in using the vendor's Udyam Registration Number. Status can change if a vendor upgrades from Small to Medium due to growth — re-verify annually.

Mechanics of Disallowance — The March 31 Test

The disallowance is determined at year-end (31 March). The question is: as of 31 March, which MSME vendor invoices remain unpaid beyond the 15/45-day limit?

The "Safe Window" for Year-End Invoices

Invoices received from MSMEs in the last 45 days before 31 March (i.e., from February 16 onwards if there is a written 45-day agreement) can be paid in April without triggering disallowance, because they were not yet due on 31 March. This creates an important planning window:

Notice Triggers — How This Reaches the Income Tax Department

Section 43B(h) violations don't stay hidden. There are three parallel compliance tracks that feed data to tax authorities:

1. Form 3CD Tax Audit Report (Old Act) / Form 26 (New Act)

The statutory tax auditor must report in the Tax Audit Report: all amounts payable to MSMEs, amounts outstanding beyond 15/45 days at year-end, and the disallowed amount. This data is submitted electronically and is visible to the Income Tax Department's AI-driven scrutiny systems.

2. Form MSME-1 (Companies Act)

All companies (not LLPs or firms) must file Form MSME-1 bi-annually with the MCA disclosing outstanding payments to MSME vendors beyond 45 days. Form MSME-1 for April–September is due by 31 October, and October–March by 30 April. MCA feeds this data to the Income Tax Department — creating a cross-verification mechanism.

3. GSTIN-Linked Transaction Data

The income tax AIS (Annual Information Statement / Form 168 under new Act) now captures GST transaction data. If MSME vendors report GST invoices to you in GSTR-1 and you haven't reflected corresponding payments — flagging is automatic.

Section 43B(h) Under New Income Tax Act 2025 — Section 37(2)(g)

Under the Income Tax Act, 2025 (effective Tax Year 2026-27), Section 43B(h) is renumbered as Section 37(2)(g). The substance and mechanics are identical:

• 15-day rule (no written agreement) continues
• 45-day maximum cap (with written agreement) continues
• Disallowance at year-end: unpaid MSME amounts at 31 March added back to taxable income
• Allowed as deduction in year of actual payment
• Reporting in new Form 26 (replaces Form 3CD) — auditor must disclose MSME payable position

For FY 2025-26 (AY 2026-27) ITR, cite old Section 43B(h). For Tax Year 2026-27 onwards, cite Section 37(2)(g) in books and audit reports.

GST and Section 43B(h) — The Base Amount Question

A common compliance question: does the 45-day payment rule apply to the invoice total including GST, or only the base amount?

• If GST claimed as ITC: Only the base amount (excluding GST) is subject to Section 43B(h). GST you claim as Input Tax Credit is a receivable, not an expense. Only the base purchase price is the deductible expense subject to 43B(h).
• If GST not claimed as ITC (expensed): The entire amount including GST is subject to Section 43B(h) conditions.

Response Strategy When You Receive a Notice

If you receive a scrutiny notice or tax audit query on Section 43B(h) disallowance:

1. Verify vendor MSME status: Extract Udyam registration certificates for all vendors cited in the notice. If any vendor is actually Medium (not Micro/Small), they are outside the scope of Section 43B(h) — disallowance is not applicable for Medium enterprises.
2. Check payment dates vs due dates: Pull bank statements and payment registers. If payment was made before the due date but booked on a different date in ERP, reconcile and provide bank evidence.
3. Verify if invoices were disputed: MSMED Act Section 17/18 provides that if there is a genuine dispute about the quality, quantity, or terms, the 45-day clock may be stayed pending dispute resolution. Document any genuine disputes.
4. Compute actual disallowance: Only amounts outstanding and unpaid as of 31 March are disallowed — not amounts that were late-paid but paid before year-end. Provide aging report as evidence.
5. Accept and file rectification if correct: If the disallowance is correctly computed, accept it, ensure the deduction is captured in the next year when payment is made, and avoid interest and penalty exposure from prolonged dispute.

Related Calculators

Related Articles