Clause 26 of Tax Audit Report: Section 43B Payments & MSME Reporting (AY 2026-27)

Clause 26 of tax audit report is the Form 3CD disclosure that reconciles amounts governed by Section 43B of the Income-tax Act, 1961. For AY 2026-27, businesses and tax auditors should identify expenses deductible only on actual payment, separately review the special MSME rule under Section 43B(h), and reconcile opening unpaid liabilities, current-year liabilities, payment dates and amounts ultimately allowable or disallowable.

What is Clause 26 of Tax Audit Report?

Section 43B overrides the normal mercantile method for specified liabilities and allows deduction only when the prescribed payment condition is met. Clause 26 of Form 3CD is the auditor-facing reporting mechanism for those amounts. The audit file should connect the general ledger, statutory returns, challans, bank payments and the income-tax computation so that every material Section 43B item can be traced from book recognition to tax deduction.

For AY 2026-27, the Income Tax Department confirms that FY 2025-26 continues to use Form 3CA/3CB with Form 3CD under the Income-tax Act, 1961. Related PGT guide: https://www.pgtandassociates.com/post/tax-audit-ay-2026-27-forms-deadline

Which Section 43B Items Require Review?

The Section 43B review commonly includes statutory taxes, duties, cess and fees; employer contributions to specified employee welfare funds; bonus or commission payable to employees; specified interest on borrowings from covered financial institutions, NBFCs and banks; leave encashment; sums payable to Indian Railways for use of railway assets; and amounts payable to micro or small enterprises that fall within Section 43B(h). Each category should be tested against the exact statutory wording applicable to the year rather than treated as one generic outstanding-expense bucket.

Clause 26 and Section 43B(h): MSME Payments Need Separate Attention

Section 43B(h) is now one of the most important Clause 26 reconciliations. Broadly, where an amount is payable to a micro or small enterprise and payment is not made within the time permitted by Section 15 of the MSMED Act, the deduction is pushed to the year of actual payment. The ordinary Section 43B relief that can allow certain payments made up to the return-filing due date does not extend in the same manner to clause (h). That is why the audit team should not combine MSME ageing with GST, PF, bonus or bank-interest testing.

The Income Tax Department’s AY 2026-27 ITR-3 validation rules expressly map amounts payable to micro or small enterprises beyond the Section 15 time limit to Form 3CD Clause 26 and Section 43B(h). The same validation framework separately maps other Section 43B categories to Clause 26 reporting. A ledger-to-ITR reconciliation is therefore critical.

How to Reconcile Clause 26 for AY 2026-27

Begin with closing liability ledgers as at 31 March 2026 and the opening Section 43B schedule brought forward from the prior year. Identify each liability by statutory category, capture when it became payable, record the actual payment date, and determine whether the amount is allowable in FY 2025-26 or carried forward for deduction in a later year.

Evidence matters. GST and other tax balances should tie to returns and challans; employer-fund contributions to portal records and bank debits; bonus and leave encashment to payroll and payment records; interest to lender statements and lender classification; railway charges to invoices and bank records; and MSME balances to vendor declarations, Udyam details, invoice dates, agreed credit terms and payment dates.

Practical Clause 26 Checklist

1. Extract every ledger that can contain a Section 43B liability. 2. Split opening unpaid items from liabilities arising during FY 2025-26. 3. Map each item to the relevant Section 43B category. 4. Verify actual payment through bank or challan evidence. 5. Create a separate MSME vendor ageing schedule for Section 43B(h). 6. Reconcile allowable and disallowable totals to the computation of income. 7. Compare final figures with ITR schedules and Form 3CD. 8. Preserve explanations for material differences between books, statutory returns and tax computation.

Worked Example: Why Payment Date Changes the Tax Deduction

Assume a company records a statutory liability of ₹4,00,000 in March 2026. If the item falls within a Section 43B category that receives the return-due-date relief and the company makes the qualifying payment within the statutory extended window, deduction may remain available for FY 2025-26 subject to the precise section conditions. If it remains unpaid beyond the permissible date, it is ordinarily disallowed for the year and becomes deductible when actually paid.

If the same ₹4,00,000 is payable to a qualifying micro or small enterprise and Section 43B(h) applies because payment crossed the MSMED Act timeline, the audit treatment cannot simply copy the return-due-date logic used for another Section 43B item. The MSME amount must be tested under the specific clause (h) rule, making vendor classification and invoice-level ageing essential.

Common Clause 26 Tax Audit Mistakes

Common errors include relying on the trial balance without checking payment evidence; treating every MSME supplier as covered without confirming whether it is a micro or small enterprise; missing old opening balances paid during the current year; netting reversals against gross liabilities; overlooking lender classification for interest; failing to match Form 3CD with the ITR; and assuming that all Section 43B items receive identical due-date relief.

Related PGT resources: Form 3CD clause list and key reconciliations — https://www.pgtandassociates.com/post/tax-audit-clauses-ay-2026-27 ; Changes in Tax Audit Report for AY 2026-27 — https://www.pgtandassociates.com/post/tax-audit-report-changes-ay-2026-27

Clause 26 vs Book Expense: The Key Difference

Financial accounting asks when an expense or liability should be recognised in the books. Section 43B asks when the tax deduction is permitted. Those are different questions. A liability can be correctly accrued under accounting principles but still be disallowed in the tax computation until the payment condition is met. Clause 26 makes that book-to-tax difference visible and auditable.

What Should Businesses Prepare Before the Tax Audit?

Finance teams should prepare a Section 43B master schedule before sending the tax-audit pack. At minimum, include vendor or payee name, nature of liability, opening balance, additions during the year, payment dates, amount paid, closing balance, statutory section, allowability conclusion and supporting-document reference. For MSME suppliers, add Udyam status, enterprise classification, invoice date and agreed payment terms.

FAQs on Clause 26 of Form 3CD

Is every unpaid expense reported under Clause 26?

No. Clause 26 focuses on amounts governed by Section 43B. Ordinary trade creditors or accruals outside Section 43B are not included merely because they remain unpaid at year-end.

Does Section 43B apply if books are maintained on mercantile basis?

Yes. Section 43B imposes an actual-payment condition on specified deductions notwithstanding the general method of accounting.

Why is MSME reporting important for AY 2026-27?

Because Section 43B(h) requires payment-timing analysis for qualifying micro and small enterprises, and the Income Tax Department’s AY 2026-27 validation framework directly maps the relevant disallowance to Form 3CD Clause 26 and return schedules.

What is the tax audit report due date for AY 2026-27?

The Income Tax Department currently states that the ordinary tax audit report for AY 2026-27 is due on 30 September 2026. Taxpayers should monitor official notifications for any later extension or special-case deadline.

Practical Takeaway

Clause 26 should be treated as a reconciliation exercise, not a year-end disclosure copied from the ledger. The highest-risk areas are payment timing, old unpaid balances, lender classification and Section 43B(h) MSME ageing. A clean schedule that reconciles books, payment evidence, Form 3CD and the ITR can prevent both missed deductions and unsupported claims.

PGT & Associates assists businesses with tax audit working papers, Form 3CD reconciliations and Section 43B/MSME review. Treatment depends on the facts, statutory category and payment timeline, so material items should be evaluated against current law and supporting records.

Primary Sources

Income Tax Department: AY 2026-27 ITR-3 Validation Rules (June 2026); Income Tax Department: Tax Audit transition FAQs; Income-tax Act, 1961, Section 43B; ICAI tax audit guidance and Form 3CD implementation material.