Tax Rule for Delayed MSME Payments (Sec 43B(h)); Section 43B(h) of Income Tax Act: Law, Intention, Practical Application & Loopholes
The Government has, over the years, taken several initiatives to strengthen the position of Micro and Small Enterprises (MSEs) in India. One of the biggest concerns for this sector has always been delayed payments from large buyers, which often choke their working capital and financial stability.
The Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) was enacted to address this problem. It mandates that payments to MSE suppliers must be made either within 15 days where there is no written agreement, or within the agreed credit period which cannot exceed 45 days. If the buyer fails to make payment within this time, he becomes liable to pay interest at three times the RBI Bank Rate, compounded monthly, until the date of actual payment. This interest is further made non-deductible under the Income Tax Act by virtue of Section 23 of the MSMED Act.
Despite this framework, delayed payments to MSMEs continued to be rampant in practice. Therefore, the Finance Act, 2023 introduced an additional measure through the Income Tax law, by inserting clause (h) in Section 43B of the Income Tax Act, 1961. This provision has been made effective from Assessment Year 2024-25 (i.e., FY 2023-24 onwards).
The Provision
Section 43B generally provides that certain expenses are allowed as deduction only when they are actually paid, irrespective of the method of accounting. Sub-clause (h) now specifically covers payments to MSMEs.
It states that any sum payable by the assessee to a Micro or Small enterprise, beyond the time limit prescribed under Section 15 of the MSMED Act, shall be allowed as a deduction only on actual payment.
In simple terms, if payment to a Micro or Small supplier is not made within the statutory time limit (maximum 45 days), the deduction for such purchase or expense will be shifted to the year in which the actual payment is made. Unlike other clauses of Section 43B, the relief of making payment before the due date of filing the return of income is not available here.
Intention of the Legislature
The Memorandum explaining the Finance Bill 2023 makes it clear that the intention is to ensure timely payments to Micro and Small enterprises. The Government wants to put tax pressure on buyers so that they either pay within the stipulated time or lose the deduction until payment is actually made.
The design is also meant to complement the MSMED Act. While the MSMED Act provides the MSME with the right to claim interest, the tax law attempts to create an incentive for buyers to avoid such delays altogether, by disallowing deduction for late payments.
How the Provision Operates
Let us understand the mechanics with an example:
- Goods worth ₹10,000 are purchased on 1st April 2024 from an MSME supplier.
- The agreed credit period is 45 days, so the payment must be made by 15th May 2024.
Now consider different payment dates:
1. Payment made on 10th May 2024: This is within the prescribed limit. The expense is fully allowed in FY 2024-25.
2. Payment made on 31st December 2024: This is after the due date, so deduction is not allowed on accrual. However, since payment is made before year-end, the deduction is allowed on 31st December itself within the same FY.
3. Payment made on 20th April 2025: Since payment was not made until after 31st March 2025, the expense will be disallowed in FY 2024-25 and allowed only in FY 2025-26, the year of actual payment.
Thus, the provision effectively ensures that deduction is linked to actual payment in case of delay. But where payment, though delayed, is cleared before 31st March, the deduction still remains in the same year.
Link with MCA’s MSME-1
A parallel reporting requirement also exists under the Companies Act. By a notification dated 22nd January 2019, every company which has outstanding dues to Micro and Small enterprises for more than 45 days must file a half-yearly return in Form MSME-1 with the Ministry of Corporate Affairs.
This return has to be filed for the periods April–September (by 31st October) and October–March (by 30th April). Companies are required to disclose the name of the supplier, PAN, Udyam registration, amount due, date from which the amount is due, and reasons for delay.
Therefore, while Section 43B(h) results in tax disallowance for dues remaining unpaid at 31st March, Form MSME-1 requires disclosure of dues outstanding beyond 45 days at each half-year end.
Loopholes and Practical Limitations
Despite its noble intention, there are several limitations in the practical application of Section 43B(h):
1. Year-end clean-up: If a buyer clears all dues on 31st March, even after keeping MSMEs waiting for several months, there is no disallowance. Thus, the real pressure is only on closing balances at year-end.
2. MSME-1 timing: If payments are strategically made just before 30th September and 31st March, there may be no dues beyond 45 days to report, resulting in a “Nil” return.
3. Supplier’s fear: Although the MSMED Act provides for interest at three times the RBI Bank Rate, many MSMEs do not demand this interest from large customers, fearing loss of business. Unless the supplier asserts this right through the MSME Facilitation Council, the buyer effectively escapes this burden.
4. Limited scope: The provision applies only to Micro and Small enterprises registered under MSMED Act, not to Medium enterprises or unregistered suppliers.
Real Burden on Buyers
While Section 43B(h) may be circumvented in some ways, there are still areas where buyers face genuine risk:
- Disallowance of year-end dues: Any outstanding dues to MSMEs at 31st March are compulsorily disallowed for tax purposes and shift to the year of payment.
- Non-deductible interest: If an MSME enforces its right, the penal interest (currently ~18–19% per annum, being 3 × the RBI Bank Rate of 6.25%) becomes a permanent, non-deductible cost.
- Disclosure pressure: MSME-1 with MCA and Clause 22 of the Tax Audit Report (Form 3CD) both require disclosure of delayed payments and disallowances, exposing the company to board and regulator scrutiny.
Conclusion
The introduction of Section 43B(h) was a welcome step in principle, reflecting the Government’s commitment to protect MSMEs from chronic delayed payments. However, in practice the provision falls short of ensuring continuous discipline in payments. By timing payments before year-end or half-year end, large buyers can often avoid both disallowance and disclosure.
The real teeth still lie in the MSMED Act’s penal interest mechanism, but this requires the MSME supplier to actively pursue the claim — something many hesitate to do.
Therefore, while the provision increases compliance visibility and forces companies to at least clean up their books at year-end, it does not fully achieve its stated intention of timely payments. Policymakers may, in future, need to tighten the law or strengthen enforcement to truly protect MSMEs.
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