Tax Compliance & MSME Advisory

Section 43B(h): The MSME Payment Rule That's Catching Businesses Off Guard

Many businesses still treat Section 43B(h) as fine print — something their accountant handles at year-end. It isn't. It's a rule that can silently disallow lakhs in expenses, trigger compounding interest at over 20% a year, and get flagged automatically by the Income Tax Department's systems before you even file. Here's what it actually requires, and how to stop it from catching you off guard.

Published by Paaramarsh Business Solutions · Tax Compliance & MSME Advisory

What Section 43B(h) Actually Says

Introduced by the Finance Act, 2023 and effective from 1 April 2024 (Assessment Year 2024–25 onward), Section 43B(h) of the Income Tax Act, 1961 adds a new condition to an existing rule. Section 43B has long said that certain expenses can only be deducted in the year they are actually paid, not merely the year they are incurred. Clause (h) extends this logic specifically to payments owed to Micro and Small Enterprises registered under the MSMED Act, 2006.

The core rule, in one line: if you buy goods or services from a registered micro or small enterprise and don't pay them within the legally prescribed window, you cannot deduct that expense in the year it was incurred — you can only deduct it in the year you actually pay.

This applies regardless of whether you follow the cash or mercantile (accrual) system of accounting, and regardless of whether your own business is registered as an MSME — only your supplier's MSME registration matters.

The 15-Day / 45-Day Rule

The payment deadline itself comes from Section 15 of the MSMED Act, 2006, and depends entirely on whether you have a written agreement with your supplier:

Situation	Maximum Payment Period
No written agreement with the supplier	15 days from the date of acceptance of goods/services
Written agreement specifying payment terms	Up to 45 days — but no longer, even if both parties agree to more

This last point is the trap most businesses miss: you cannot contract your way out of the 45-day cap. Even if your supplier is happy to offer 60- or 90-day credit terms in writing, the law caps the period that matters for tax deduction purposes at 45 days. Anything beyond that, however cordial the commercial arrangement, exposes you to disallowance.

Worked Example: How the Disallowance Actually Bites

Illustration

A textile trading firm buys ₹80 lakh worth of fabric in January 2026 from three MSME-registered weaving units, with written agreements specifying 60-day credit terms.

Because 60 days exceeds the legal 45-day cap, the firm is not protected by its own contract — the moment payment crosses 45 days from acceptance, the expense becomes subject to disallowance under Section 43B(h), regardless of what the agreement says.

If the firm pays only in April 2026 (well beyond 45 days), the entire ₹80 lakh is disallowed as a deduction in FY 2025–26 — increasing that year's taxable income by ₹80 lakh — and can only be claimed as a deduction in FY 2026–27, the year the payment is actually made.

The Double Penalty Most Businesses Don't See Coming

The tax disallowance is only half the cost of a late payment. Section 16 of the MSMED Act separately imposes compound interest on the outstanding amount, calculated at three times the RBI's bank rate, from the date payment falls due. With the RBI bank rate at roughly 6.75% (as of mid-2026), that works out to an effective interest rate of around 20% per annum, compounding monthly — and to make matters worse, this interest is itself not tax-deductible under Section 23 of the MSMED Act.

Cost Component	Impact on a ₹50 Lakh Payment, 60 Days Late
Income tax on the disallowed expense	₹50,00,000 added to taxable income at your applicable rate
Compound interest under MSMED Act Sec. 16	~20% p.a., compounding monthly, on ₹50,00,000 for the delay period — and not deductible
Combined effect	Almost always far more expensive than simply arranging payment on time

The government's position: in a July 2026 Rajya Sabha response, the Ministry of Finance confirmed it has no plans to amend or relax Section 43B(h), reiterating that the provision exists specifically to address the long-standing working-capital challenges MSEs face when larger buyers delay payment. Businesses hoping for a rollback or extension should plan on the assumption that this rule is here to stay.

Why It Is Harder to Quietly Miss Than Businesses Assume

A common (and increasingly risky) assumption is that a missed disclosure will simply go unnoticed. That is no longer realistic:

Every tax audit report (Form 3CD) requires disclosure of outstanding MSME dues under Clause 22 — auditors are required to report the figure, not just the taxpayer.
The Central Processing Centre (CPC) of the Income Tax Department is configured to automatically cross-check MSME-related outstanding amounts reported in tax audit data against what has been added back in the return. A mismatch is flagged systematically, not discovered by chance.
Beyond income tax exposure, companies also face potential penalties under the Companies Act for related non-filing obligations concerning outstanding MSME dues — a third layer of exposure distinct from the tax consequence itself.

An Important Renumbering to Know About

With the new Income Tax Act, 2025 coming into effect from Tax Year 2026–27 (1 April 2026), Section 43B of the 1961 Act has been renumbered. The MSME payment provision — today's Section 43B(h) — will be carried forward as Section 37(2)(g) of the new Act. For tax audits and assessments relating to FY 2024–25 and FY 2025–26 (AY 2025–26 and AY 2026–27), you should still cite Section 43B(h) of the 1961 Act — but be prepared for the new section number to appear in filings and professional advice going forward.

A Practical Checklist for Businesses

Action	Why It Matters
Identify which suppliers are MSME-registered	The rule only applies to registered Micro and Small Enterprises — ask suppliers for their Udyam Registration Number and maintain a record.
Cap all written agreements at 45 days, not longer	Longer contractual credit terms offer no tax protection — they only create a false sense of security.
Track "date of acceptance," not invoice date	The clock starts from acceptance of goods/services, which can differ from the invoice date — get this wrong and your payment window calculation will be wrong too.
Reconcile MSME payables before year-end, not after	An overdue amount paid before 31 March can still qualify for deduction in that year — waiting until the return is being prepared to check is too late to fix anything.
Ensure Form 3CD Clause 22 and your ITR computation match	The CPC's automated matching means a disclosed-but-not-added-back figure will very likely be caught and adjusted regardless.
Treat this as a cash-flow planning issue, not just a tax issue	Given the compounding interest exposure, prioritising MSME vendor payments within 45 days is usually the cheapest option on the table — even ahead of other short-term financing needs.

The bottom line for MSME clients and their buyers: Section 43B(h) was designed to tilt bargaining power back toward small suppliers who have historically absorbed the cost of large buyers' delayed payments. If you are a buyer, the compliant response isn't clever contract drafting — it's simply paying on time. If you are an MSME supplier, this rule is now one of your strongest practical levers to enforce prompt payment, since your buyer's own tax position depends on honouring it.

Key Takeaways

Insight	Detail
The 45-day cap is absolute	Written agreements cannot extend the deduction-protecting payment window beyond 45 days, no matter what commercial terms are agreed.
The real cost is two-layered	Late payment triggers both a tax disallowance and non-deductible compound interest at roughly 20% p.a. — the combined cost usually dwarfs any cash-flow benefit of delaying payment.
It's not a rule you can quietly miss	Form 3CD Clause 22 disclosure plus CPC's automated cross-checking make non-compliance highly likely to be caught.
No relief is coming	The government has explicitly ruled out amending or relaxing the provision as of mid-2026 — plan around it as a permanent feature of doing business with MSME suppliers.

Sources

Income Tax Act, 1961, Section 43B(h) (inserted by the Finance Act, 2023)
Micro, Small and Medium Enterprises Development Act, 2006 — Sections 15, 16 & 23
Ministry of Finance, response to Rajya Sabha Unstarred Question, July 2026
IndiaFilings — Section 43B(h): New MSME 45-Day Payment Rule
Tax Garden — Section 43B(h): MSME 45-Day Payment Rule and Tax Disallowance
Tax Tip — Section 43B(h): Compliance, Deduction Timing & Litigation Risks
ClearTax Advisors — Section 43B(h): MSME 45-Day Payment Rule & Tax Guide
Busy.in — Section 43B(h) MSME Payment Rule, 2026 Guide

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Disclaimer: This article is prepared for informational and educational purposes only and reflects the understanding of Section 43B(h) of the Income Tax Act, 1961 and related MSMED Act provisions as of the time of writing. Tax law, interest rate references, and provision numbering (including the transition to the Income Tax Act, 2025) are subject to change. This content should not be construed as legal or tax advice. Readers are strongly advised to consult a qualified Chartered Accountant or tax professional regarding their specific facts before making compliance or payment decisions. Paaramarsh Business Solutions does not claim responsibility for independent verification of every fact referenced above.