Section 43B(h) MSME Payment Disallowance for AY 2026-27: 15/45-Day Rule, Form 3CD Clause 26 & Audit Checklist
Updated: Sep 6
Among the direct tax provisions governing business taxation in Assessment Year 2026-27 (Financial Year 2025-26), Section 43B(h) of the Income-tax Act, 1961 continues to demand the highest degree of diligence from corporate CFOs, finance teams, and statutory tax auditors.
Enacted to enforce commercial financial discipline and safeguard the liquidity of micro and small enterprises, Section 43B(h) disallows business expenses payable to registered micro and small enterprises if payments are delayed beyond the statutory timelines mandated under the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006.
In this technical audit guide, PGT & Associates (Chartered Accountants, Ahmedabad) provides an authoritative legal analysis of Section 43B(h), the crucial distinction between traders and manufacturers, the strict non-applicability of the Section 43B proviso, and a practical Form 3CD reporting checklist for AY 2026-27.
1. The Statutory Framework: Section 43B(h) Explained
Section 43B of the Income-tax Act specifies certain deductions that are allowable only on actual payment. Clause (h) of Section 43B encompasses:
"Any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006."
Crucial Distinction: Section 43B(h) Is Excluded from the Proviso
For all other clauses of Section 43B (such as GST payable, employee PF/ESI, interest to banks, or bonus), taxpayers enjoy the benefit of the first proviso—meaning deductions are allowed if payment is deposited on or before the due date of filing the Income Tax Return under Section 139(1).
Section 43B(h) is explicitly excluded from the first proviso.
If payment to an eligible micro or small enterprise is made after the expiration of the timeline specified in Section 15 of the MSMED Act, the expense cannot be allowed in that financial year, even if it is settled before the tax audit due date (30th September) or ITR deadline (31st October). It will be allowed as a deduction strictly in the subsequent financial year in which actual payment is remitted.
2. Statutory Timelines Under Section 15 of the MSMED Act, 2006
Section 15 of the MSMED Act dictates the exact period within which a buyer must settle invoices with a micro or small supplier:
**Where Written Agreement Exists • Legal Parameter: Credit period agreed upon in writing between buyer and supplier • Maximum Payment Window: Agreed date, but cannot exceed 45 days** from day of acceptance
**Where No Written Agreement Exists • Legal Parameter: Statutory default ("Appointed Day") • Maximum Payment Window: Within 15 days** from day of acceptance or deemed acceptance
Meaning of "Day of Acceptance" and "Deemed Acceptance"
Day of Acceptance: The day of actual delivery of goods or the rendering of services.
Objection Window: If the buyer makes an objection in writing regarding the quality or quantity of goods/services within 15 days of delivery, the "day of acceptance" is deemed to be the day on which the supplier resolves the defect.
3. Enterprise Classification Matrix: Who Qualifies Under Section 43B(h)?
Section 43B(h) applies only to transactions with suppliers classified as Micro or Small enterprises registered under the Udyam portal. It does not apply to Medium enterprises.
Composite Investment & Turnover Criteria
Micro Enterprise: Investment in Plant & Machinery $\le$ Rs. 1 Crore AND Turnover $\le$ Rs. 5 Crores.
Small Enterprise: Investment in Plant & Machinery $\le$ Rs. 10 Crores AND Turnover $\le$ Rs. 50 Crores.
Medium Enterprise: Investment $\le$ Rs. 50 Crores AND Turnover $\le$ Rs. 250 Crores (Excluded from 43B(h)).
The Critical Trader vs. Manufacturer Exemption
One of the most litigated questions is whether suppliers registered under Udyam as Wholesale or Retail Traders (NIC codes 45, 46, and 47) trigger Section 43B(h) disallowances.
Ministry of MSME Clarification: By Office Memorandum No. 5/2(2)/2021-E/P & G/Policy dated 2nd July 2021 and subsequent circulars, retail and wholesale traders were allowed Udyam registration strictly for the limited purpose of Priority Sector Lending (PSL).
Legal Impact on Section 43B(h): The delayed payment protections under Chapter V of the MSMED Act (Sections 15 to 24) do not extend to traders. Consequently, delayed payments to registered traders do not attract disallowance under Section 43B(h). Auditors must independently verify vendor Udyam certificates to ascertain the principal activity (Manufacturing/Service vs. Trading).
4. Compound Interest Under Section 16 & Its Tax Disallowance
Where a buyer fails to make payment within the statutory 15 or 45-day window, Section 16 of the MSMED Act imposes mandatory interest:
Interest Rate: Three times the Bank Rate notified by the Reserve Bank of India (RBI).
Compounding: Compounded with monthly rests from the appointed day or agreed date.
Mandatory Nature: The buyer cannot contract out of this liability; agreement terms seeking to waive statutory interest are legally void.
Complete Tax Disallowance Under Section 23
Under Section 23 of the MSMED Act, read with Section 40(a) of the Income-tax Act, no deduction is allowable in computing taxable income for any interest paid or payable under the MSMED Act. The penal interest must be added back in full during the computation of income.
5. Form 3CD Reporting Requirements: Clause 22 & Clause 26
In the Tax Audit Report for AY 2026-27, tax auditors must examine Section 43B(h) under two distinct clauses of Form 3CD:
Clause 26(B) - Pre-condition for Disallowance
Under Clause 26, the auditor must disclose:
Any sum payable to an enterprise beyond the specified time limit at the beginning of the financial year.
Any sum incurred during the financial year and remaining unpaid beyond the Section 15 timeline as of 31st March 2026.
Quantify the exact amount disallowed and added back to taxable business profits for FY 2025-26.
Clause 22 - Disclosure of MSME Interest
Under Clause 22, the auditor must detail the amount of interest inadmissible under Section 23 of the MSMED Act, corroborating the disclosures made in the assessee's audited financial statements under Section 22 of the MSMED Act.
6. Practical Compliance & Audit Checklist for AY 2026-27
Tax departments and corporate finance managers should execute the following verification steps prior to finalizing the tax audit:
[ ] Vendor Udyam Master Verification: Obtain and validate Udyam registration certificates for all active trade creditors as of 31st March 2026.
[ ] Activity Verification: Review vendor certificates to identify whether the supplier is registered as a Manufacturer, Service Provider, or Retail/Wholesale Trader.
[ ] Contract Review: Verify whether valid written contracts or purchase order terms exist stipulating credit periods up to 45 days. In the absence of written terms, apply the 15-day ceiling.
[ ] Outstanding Ageing Analysis: Prepare an ageing analysis of creditors outstanding as of 31st March 2026 to detect invoices exceeding the statutory window.
[ ] Subsequent Payment Tracking: Track whether unpaid amounts as of 31st March 2026 were settled subsequently in FY 2026-27 to establish future-year tax deduction eligibility.
[ ] Year-End Accruals Review: Scrutinize year-end provision accounts (unbilled expenses, GRN clearing ledgers) to ensure liability to micro/small vendors is correctly evaluated.
Practical Compliance & Advisory Toolkit
To assist practicing Chartered Accountants, corporate finance teams, and tax practitioners in executing rigorous statutory compliance:
This toolkit includes comprehensive clause-by-clause documentation templates, cross-referencing workpapers for Form 3CA/3CB, Section 43B(h) MSME tracking schedules, and Clause 44 GST expenditure reconciliations designed to streamline statutory audits.
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About PGT & Associates
Established in 1996 and based in Ahmedabad, PGT & Associates is an esteemed Chartered Accountancy firm delivering high-caliber Audit & Assurance, Direct & Indirect Tax Structuring, MSME Regulatory Advisory, and Transaction Advisory services to corporate and mid-market clients across India.
For professional consultations on Section 43B(h) impact assessments, tax audit finalization, or enterprise compliance structuring, visit https://www.pgtandassociates.com or reach out to info@pgtandassociates.com.
Professional Disclaimer
This publication is issued by PGT & Associates, Chartered Accountants, strictly for academic and informational purposes in conformity with the Code of Ethics prescribed by the Institute of Chartered Accountants of India (ICAI). The insights herein do not constitute formal legal or tax counsel. Clients must obtain customized professional advice tailored to their specific contractual arrangements.
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