Budget 2023 introduced Section 43B(h) to the Income Tax Act, disallowing deductions for payments to Micro and Small Enterprises (MSEs) if not made within the time limits prescribed under the MSMED Act. This seemingly simple provision has significant implications for businesses.
What Does Section 43B(h) Say?
Section 43B(h) provides that any sum payable to a Micro or Small Enterprise as a buyer shall be allowed as a deduction only in the year of actual payment — if the payment is not made within the time limit prescribed under Section 15 of the MSMED Act. Section 15 prescribes: 15 days (if no agreement) or 45 days maximum (if written agreement exists).
Who is Affected?
Any taxpayer — individual, firm, company, LLP — that purchases goods or services from a Micro or Small Enterprise (registered under Udyam) and has outstanding dues beyond 45 days. Medium Enterprises are NOT covered — the provision applies only to Micro and Small. This requires you to know which of your vendors are registered MSEs.
Impact on Tax Liability
If you owe ₹50 lakh to an MSE vendor and haven't paid within 45 days by March 31, you cannot claim that ₹50 lakh as a deduction this year. It will only be deductible in the year you actually pay. This can significantly increase your taxable income and advance tax liability.
Practical Challenges
Many businesses don't track whether their vendors are MSE-registered. Vendors may not proactively disclose their Udyam registration status. Payment terms in existing contracts may exceed 45 days. ERP systems may not flag MSE vendors for priority payment.
Steps to Comply
Audit your vendor master — identify all Udyam-registered Micro and Small vendors. Update your vendor onboarding process to capture Udyam registration details. Review payment terms in all vendor agreements. Prioritise payment to MSE vendors before March 31. Update your ERP/accounting software to flag MSE dues crossing 45 days.
Our Advisory
We recommend conducting a one-time vendor MSE audit before your year-end. For large businesses with hundreds of vendors, we can help implement a systematic process. For companies facing disallowance, we can help quantify the impact and plan advance tax accordingly. Contact us for a 43B(h) compliance review.
Need Expert Advice on This Topic?
Our senior CA professionals are available for confidential consultations. We respond within one business day.
Section 43B(h), inserted by Finance Act 2023 effective from 1 April 2024, provides that any sum payable to a Micro or Small Enterprise (as defined in the MSMED Act, 2006) shall be allowed as a deduction only in the year of actual payment — not on accrual basis — if the payment is made beyond the time limit prescribed under Section 15 of the MSMED Act. Section 15 of the MSMED Act requires payment within the agreed credit period (maximum 45 days if written agreement exists) or 15 days if no written agreement. If payment is delayed beyond these limits, the entire outstanding amount is disallowed and taxable in the year it was due.
You should collect a self-declaration or Udyam Registration Certificate from each vendor. The MSMED Act classifies enterprises as Micro (investment ≤ ₹1 crore, turnover ≤ ₹5 crore), Small (investment ≤ ₹10 crore, turnover ≤ ₹50 crore), or Medium. Section 43B(h) applies ONLY to Micro and Small enterprises — Medium enterprises are not covered. You can also verify the Udyam Registration Number on the Government's Udyam portal. Maintain a register of all MSME vendors with their Udyam numbers for Section 43B(h) compliance.
If there is a written agreement with the MSME vendor, payment must be made within 45 days of acceptance of goods/services. If there is no written agreement, payment must be made within 15 days of acceptance. Acceptance means the day of actual delivery or the deemed acceptance date (15 days after delivery if no objection is raised). Amounts outstanding beyond these periods as of 31 March of the financial year are disallowed under Section 43B(h) and taxable as deemed income.
Section 16 of the MSMED Act requires you to pay compound interest at 3× the bank rate notified by RBI on any amount due beyond the prescribed period. This interest is NOT deductible under the Income Tax Act — Section 23(e) of the MSMED Act explicitly states that the interest payable under Section 16 shall not be allowed as deduction for income tax purposes. This double impact — disallowance of principal and non-deductibility of interest — makes timely payment to MSME vendors critical for tax efficiency. Shahi & Co. assists companies in structuring their vendor payment cycles to ensure compliance.