MSME payment disallowance: the buyer’s problem

The rule, and the number it carries now

Section 37 of the Income-tax Act, 2025 is headed certain deductions allowed on actual payment basis only. Sub-section (2), clause (g), covers an amount payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the MSMED Act, 2006. Where that applies the buyer gets the deduction only in the tax year in which the money is actually paid, irrespective of the accounting method followed and of the year the liability was incurred.

The ordinary escape hatch does not reach it. Sub-section (3) says that where the sums in that list are paid after year end but on or before the return filing due date, the deduction still stands in the year the liability arose, and then expressly excepts clause (g) from that relief. Buy in March, pay in June, and the expense lands in the following tax year. There is nothing to do about it at filing time.

Two section numbers, and right now you need both

Almost everything written on this rule calls it section 43B(h), and for one more filing season that is still correct. Section 43B(h) went into the Income-tax Act, 1961 through the Finance Act, 2023, applied from assessment year 2024-25, and was explained in CBDT Circular 1 of 2024.

The Income-tax Act, 2025 repealed the 1961 Act with effect from 1 April 2026, but section 536 of the new Act saves the old one for proceedings relating to any tax year beginning before that date. So FY 2025-26, the return and tax audit sitting on the desk now, still runs on 43B(h). FY 2026-27, the year the business is actually trading in and making payment decisions for, runs on section 37(2)(g). Carry both and put the year on every working paper, because a note that says only 43B(h) will be wrong by the time anyone acts on it.

Watch the number itself as well, because it collides. Section 37 of the old Act was the general deduction for business expenditure, the one everybody quoted for ordinary expenses. That provision is now section 34. A bare reference to section 37 in anything written around the changeover is ambiguous, so always name the Act alongside the number.

Who it actually bites

Three things to get straight, because the rule is misdescribed more often than not.

It is the buyer’s deduction at stake, never the supplier’s income. That is what makes it unusual in this lane: the cost lands on the party holding the cash, which is the party that chose to hold it.

It runs only where the supplier is a micro or small enterprise. Medium enterprises sit outside it, exactly as they sit outside the section 15 payment obligation itself. The buyer’s own size is irrelevant to the test. Worth noting that the Income-tax Act imposes no registration condition of its own here, and carries no mention of Udyam at all. The registration question arrives through the MSMED Act’s own definition of a supplier, not through the tax provision.

Traders are the contested edge, and this is where the original provision generated most of its argument. Retail and wholesale trade were brought inside the MSME definition by a Ministry of MSME office memorandum dated 2 July 2021, and the Reserve Bank’s own FAQ records that inclusion as being for the limited purpose of priority sector lending. Read that way, a pure trading supplier’s Udyam certificate does not carry the section 15 payment protection, so it does not trigger the buyer’s disallowance either. That is the common reading and no published clarification settles it, so the sensible control is to capture the principal activity from the certificate and let your advisor take the position on the file.

One clock, two consequences, opposite directions

The same 45 days drives both halves of this, which is the thing worth internalising. Miss it and section 16 of the MSMED Act gives the supplier compound interest with monthly rests at three times the RBI bank rate, while the Income-tax Act moves the buyer’s deduction into a later year. Section 23 of the MSMED Act then refuses the buyer any deduction for that interest, so it is paid out of post-tax money. One missed date, two bills, pointing in opposite directions.

Where there is no written agreement at all the window is 15 days rather than 45, which is the detail that catches buyers who never papered the relationship properly.

Size the exposure rather than debating it. A crore of unpaid micro and small balances sitting on the books at year end does not reduce that year’s taxable profit at all, so the tax on a crore of expense moves forward twelve months. That is a financing event, and it belongs in the same conversation as supplier payment terms and your cash conversion cycle rather than being discovered during the audit.

What an operator actually does about it

Three changes, none of them a project.

Vendor master. Four mandatory fields at onboarding: Udyam registration number, enterprise class as micro, small or medium, principal activity from the certificate, and the registration date. This is a tax classification field set and nothing else, so keep it clear of your supplier qualification work, which answers a different question entirely. Refresh the class annually, because enterprises move between classes as turnover grows and a vendor who was small last year may not be this year.

Payment terms policy. Stop writing 60 and 90 day terms for micro and small vendors. The term does not hold beyond 45 days, so a long term buys you nothing except a disallowance and an interest liability you cannot deduct. Write 45 days or shorter for that cohort and route any exception through a named approver.

Year-end review. Pull the ageing of micro and small payables in the second week of March, not in September when the auditor asks for it. Anything on that list which will not be paid before the year closes is a deduction already lost for the year, and the only lever left is paying it. A fortnight of notice is the difference between a payment decision and an audit finding.