MSME Payments Under the Spotlight Interest, Disallowance & Audit Disclosures

Micro, Small & Medium Enterprises (MSMEs) are the backbone of the Indian economy. To protect their cash flow, the law mandates that buyers must pay MSME suppliers within specified time limits. Failure to comply not only attracts interest penalties but also tax disallowances. From FY 2024-25 (i.e. Assessment Year 2025-26) onward, the Income-Tax Act has introduced stricter consequences (via Section 43B(h)) and enhanced disclosure requirements in the tax audit report (Form 3CD).

Let’s unpack how this works in practice:

MSME payment rules and interest on delayed payments
Deductibility (or disallowance) for the buyer
What the supplier can do (and claim)
Reporting in Income Tax Return
Reporting in Tax Audit Report (Form 3CD)

1. MSME Payment Rules & Interest on Delay

a. MSMED Act – baseline obligations

Under Section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, a buyer (recipient of goods or services) must make payment to the MSME supplier:

Within 15 days of acceptance (or deemed acceptance) if there is no written agreement specifying credit terms
Within the period agreed in writing, but in no case exceeding 45 days, if there is a written agreement

If the buyer fails to make timely payment, the supplier is entitled to interest on delayed payments.

b. Amendment via Finance Act, 2023 – Section 43B(h)

The Finance Act, 2023 inserted clause (h) into Section 43B of the Income-Tax Act, effective April 1, 2024 (i.e. for FY 2024-25 onward).

Key features:

If a buyer fails to pay an MSME supplier within the prescribed time, then the buyer cannot deduct that cost (or expense) in that year; instead, the deduction is allowed only in the year in which payment is actually made.
In effect, the expense (principal) is disallowed (i.e., added back) unless paid timely.
Interest charged by the MSME supplier is separately allowed (i.e. interest is deductible).
Further, the buyer is liable to pay compound interest (monthly) at 3 times the RBI bank rate from the due date (or the day after the 15-day default).
Importantly, that interest cost (i.e. the penalty interest for delay) is not allowed as a deduction in the computing of business profits.

Thus, the law imposes a double pain: (i) you lose the deduction for the unpaid principal, and (ii) you cannot deduct the penalty interest.

c. Effective date & transitional treatment

The clause (h) is operative from April 1, 2024.
Purchases (or services) made prior to that date but unpaid don’t fall under clause (h).
Buyers must ensure that their procurement/payment cycles get aligned to the new timelines to avoid tax disallowance.

2. Deductibility / Disallowance from Buyer’s Perspective

Let’s examine what happens from the perspective of a buyer (i.e. the entity procuring goods or services from an MSME supplier).

a. When payment is timely

The principal amount of the expense is deductible in the year in which the expense is incurred (i.e. accrual or incurred in books).
If the buyer pays within 15 days (no agreement) or within agreed credit/45 days (with agreement), the deduction is allowed.

b. When payment is delayed

The principal (i.e. the amount payable) is disallowed in that year. It needs to be added back to income.
The expense becomes deductible only in the year in which actual payment is made.
The buyer is also liable to pay the interest penalty (compound interest at 3× bank rate) to the supplier.
That interest penalty is not deductible. It’s a “disallowed expense.”

c. Accounting & tax treatment illustration

Suppose:

You purchase goods from an MSME supplier in March 2025, amount ₹1,00,000
The supplier gives 30 days’ credit (written agreement)
You pay in May 2025 (i.e. beyond 45 days)

In FY 2024-25:

You cannot deduct ₹1,00,000 (principal) in computing profits
You may have to compute interest (penalty) that you owe to supplier (not deductible)

In FY 2025-26:

When you actually pay ₹1,00,000, you can deduct that expense
But the interest you pay as penalty is not deductible

Thus, cash flow management becomes critical.

d. Interaction with Section 43B (other clauses)

Recall, Section 43B is the “payment‐based” deduction provision (for certain expenses like tax, employer contribution, etc.). Clause (h) is an addition to that. The interplay must be carefully managed.

3. Reporting in Income Tax Return

For a taxpayer (buyer) who is required to file audited returns (i.e. whose turnover exceeds the audit threshold), reporting of disallowances under 43B(h) should be consistent with what is reported in the audit report (Form 3CD).

Key points:

The amount disallowed under clause (h) (i.e. unpaid principal to MSME suppliers) must be added back while computing “Book Profit to Taxable Profit” (i.e. under the Tax Audit Schedule).
When the actual payment is made in a later year, that amount is allowed as deduction in that later year.
The taxpayer should correctly reflect the “disallowed amount” in the return and ensure reconciliation with audit schedules and working papers.
In case of mismatch or non‐reporting, the CPC (Central Processing Centre) may recompute and add back the disallowance in processing the ITR.

4. Reporting in Tax Audit Report (Form 3CD)

Form 3CD is a detailed annexure to the tax audit report (Form 3CA / 3CB) under Section 44AB. It requires disclosure of many particulars including MSME payments, disallowances, interest, etc.

From AY 2025-26 (i.e. for FY 2024-25), certain new / enhanced disclosures are mandated.

a. New / enhanced clauses

Clause 22: Now requires detailed disclosure of payments made (or payable) to Micro & Small Enterprises (MSEs), whether those payments were made within the allowable period or are delayed, and the amounts delayed.
Clause 26: Requires disclosure of amounts disallowed under Section 43B(h) from earlier years, how much of that is paid in current year, and how much is still outstanding.

b. What exactly to disclose

Under clause 22, the auditor must provide:

Total amount payable to MSMEs
How much was paid within the prescribed period
How much was paid beyond the prescribed period
Interest liability (if any) on delayed payments (though this interest is non-deductible)
Reason(s) for delay, if any (optional / as per auditor’s notes)

Under clause 26, the auditor must disclose:

The amount disallowed in earlier years under Section 43B(h)
How much of that disallowed sum has been paid in the current year
How much remains unpaid as on the year-end (if any)

c. Impact of non-disclosure

If the buyer / auditor fails to properly disclose the disallowed amounts or mismatches between books and Form 3CD, it may lead to notices or re-assessment. Also, the ITR may be processed with automatic addition of the disallowed amounts.

Conclusion

The amendment via Section 43B(h) marks a significant shift in how procurement and vendor payments are viewed from a tax lens. It imposes stricter discipline on buyers to pay MSME suppliers promptly, failing which they suffer from disallowance of the principal cost and non-deductibility of the penalty interest.

On the reporting side, the enhanced disclosure in Form 3CD (Clauses 22 & 26) ensures transparency and audit scrutiny. Buyers must align their accounting, vendor-management, and cash flows accordingly. Meanwhile, MSME suppliers should maintain proper records to enforce their rights to interest and recognition of delayed payments.

Post Views: 25