Section 43B(h) — Disallowance for Delayed Payments to MSME Suppliers

How Section 43B(h) shifts MSME payment enforcement to the buyer's tax return, the MSMED Act timelines that trigger it, and the operational changes most businesses have made.

Section 43B(h) was introduced by the Finance Act, 2023 and became applicable from assessment year 2024-25. In the two years since, it has materially changed how larger businesses handle their payables to micro and small enterprise (MSE) suppliers. The provision is short in text but wide in impact, and the cost of getting it wrong is the disallowance of the entire expense in the year of accrual.

This article explains the provision, its interaction with the MSMED Act payment timelines, and the operational changes businesses have made to comply.

The provision

Section 43B(h) of the Income-tax Act, 1961 provides that any sum payable by an assessee to a micro or small enterprise beyond the time-limit specified in Section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, is allowed as a deduction in the previous year in which the sum is actually paid.

The wording is critical: the deduction is allowed only on actual payment, not on the accrual basis that normally governs Section 43B items. Most other Section 43B items (taxes, interest on borrowed capital, employer's PF contribution, etc.) allow deduction on accrual if paid by the due date of filing the return. Section 43B(h) does not extend the same accommodation.

The MSMED Act payment timeline

Section 15 of the MSMED Act mandates payment to a micro or small enterprise supplier within the time agreed in writing between the buyer and the supplier, or where there is no agreement, within fifteen days from the day of acceptance of the goods or services.

Where there is a written agreement, the maximum period that can be agreed is forty-five days from the day of acceptance.

The combined effect: any payment beyond forty-five days from the day of acceptance — or the agreed period if shorter than forty-five days — is delayed for Section 43B(h) purposes.

What day of acceptance means

Section 2(b) of the MSMED Act defines the day of acceptance as the day of actual delivery, or where the buyer raises an objection in writing within fifteen days, the day on which such objection is removed by the supplier.

In practice, this means the clock starts from the date of physical delivery — not from the date of invoice or the date of receipt of invoice. Businesses that delay raising the GRN (goods receipt note) or backdating the invoice to manage cash flow find this provision particularly disruptive.

Who is a micro or small enterprise

The supplier qualifies as an MSE only if:

• The supplier is registered under the MSMED Act (the Udyam Registration Certificate confirms this)
• The supplier's classification is micro or small — not medium
• The supplier supplied goods or services in the relevant year

A medium enterprise is not covered. A trader is not covered by Section 43B(h) per the present interpretation (specific MSMED notifications govern this — the position has evolved and should be re-confirmed before relying on it). An unregistered supplier is not covered by Section 43B(h) for the purposes of this section, since the supplier must be registered under the MSMED Act for the benefit of the time-bar to apply.

The disallowance mechanism

If a buyer is liable to pay an amount to an MSE supplier within the time-frame above, and the payment is delayed beyond that time-frame, the expense is disallowed in the year of accrual and allowed only in the year of actual payment.

The disallowance is automatic — it is not contingent on the supplier raising the issue with the buyer or with the MSMED Facilitation Council. The buyer's auditor is expected to identify the disallowance during the tax audit (Clause 22 of Form 3CD requires disclosure).

The first-year practical impact

The first year of implementation (FY 2023-24, AY 2024-25) saw significant disruption to AP processes:

• Larger buyers updated their vendor master to flag MSE suppliers
• Payment terms in supplier contracts were re-examined, with many shortened to within forty-five days
• AP teams introduced exception reports to identify ageing payables to MSE suppliers
• Tax audit teams added Section 43B(h) review as a standalone work-paper

A common compliance gap is the absence of a documented Udyam Registration Certificate from suppliers. Without it, the buyer cannot conclusively determine MSE status — and in the absence of MSE status, Section 43B(h) does not apply. Many AP teams now require the certificate as part of vendor onboarding, with annual re-verification.

The interaction with TDS

A separate but related compliance is the TDS or TCS on payments to MSE suppliers. The TDS rate is not different for MSE suppliers — the same rates apply under Sections 194-C, 194-J, 194-H, and others — but the disallowance under Section 43B(h) is on the gross amount payable, not the net of TDS.

The practical implication: if the gross amount of Rs. 1,00,000 is disallowed under Section 43B(h), the TDS of Rs. 1,000 already deducted is not separately recovered — it has already been remitted and reported. The disallowance increases taxable income by the gross amount; the TDS already deducted is unaffected.

Operational changes most businesses have made

• Vendor onboarding now requires the Udyam Registration Certificate as a mandatory document; the vendor master flags MSE status with a refresh date
• PO and contract templates have shortened payment terms to within forty-five days of delivery for MSE suppliers, even if the buyer's standard terms are longer
• AP teams run a weekly or monthly exception report of unpaid MSE invoices approaching the forty-five-day mark
• Tax audit work-paper now includes a standalone schedule that lists all MSE suppliers, opening balance, additions, payments, and ageing
• Year-end provision review identifies any MSE payable accrued in the year but unpaid at year-end for the Section 43B(h) disallowance disclosure
• MSME Form 1 — half-yearly filing under the Companies Act for outstanding payments to MSE suppliers beyond forty-five days — is now reconciled with the Section 43B(h) work-paper

A note on aggressive positions

Some buyers have explored whether Section 43B(h) can be avoided by delaying the GRN, by reclassifying the supplier, or by raising disputes to extend the day of acceptance. These positions need to be evaluated against the substance of the transaction — Section 43B(h) is a substance-based provision, and the tax department is expected to look at the underlying delivery and acceptance facts rather than the documentary classification chosen by the buyer. The cost of an unsustainable position is a multi-year disallowance plus interest, and a litigation overhang for the period of the dispute.

What this provision is signalling

Section 43B(h) is part of a broader policy push to bring MSE payments within the discipline of statutory timelines. The MSMED Act has had the forty-five-day timeline since 2006, but enforcement was largely supplier-driven via the Facilitation Council mechanism, which most small suppliers did not invoke for fear of damaging the commercial relationship. Section 43B(h) shifts the enforcement to the buyer's tax return — a much more visible and recurring touchpoint.

For most well-run businesses, the practical answer has been to align AP processes with the forty-five-day timeline universally rather than try to track exceptions. The administrative cost of universal compliance is lower than the cost of selective compliance plus the audit-defence work for missed cases.