Section 43B(h) of Income Tax Act: MSME Payment Rule

Section 43B(h) of the Income Tax Act represents one of the most impactful reforms affecting business payments to Micro and Small Enterprises (MSMEs). Introduced to strengthen timely payments to small businesses, the provision ensures that large companies, corporates, and other buyers cannot delay payments to MSMEs without facing tax consequences. This rule effectively links timely settlement of dues with the deductibility of business expenditure, compelling buyers to honor their contractual and statutory obligations. With MSMEs constituting a significant portion of India’s supply chain ecosystem, Section 43B(h) aims to enhance their cash flows, protect them from delayed receivables, and promote a healthier business environment.
            

The central objective of Section 43B(h) is to prevent cash flow stress in the MSME sector caused by chronic payment delays from large buyers. MSMEs often operate with limited working capital and depend heavily on timely payments. Delays in payments have historically hampered their growth, leading to liquidity crises and operational challenges.
The legislative intent behind the provision is to impose a financial deterrent on buyers. By disallowing expenditure related to MSME purchases if not paid on time, the law ensures that delayed payments result in a higher tax liability for the buyer. This creates strong compliance pressure and directly encourages timely settlement of MSME invoices.
            

Section 43B(h) applies to all entities—companies, firms, LLPs, and other businesses—who purchase goods or services from enterprises classified as Micro or Small under the MSME Act. The rule applies only when the supplier is a registered MSME and the business has procured goods or services in the course of business.
Further, the rule is not dependent on the size of the buyer; even small businesses must comply if they deal with Micro or Small Enterprises. Importantly, Medium Enterprises are excluded from this provision, and payments to unregistered suppliers remain outside its scope.
            

Only Micro and Small enterprises registered under the MSME Development Act are covered under Section 43B(h). A Micro enterprise qualifies based on lower investment and turnover limits, while a Small enterprise falls under the next tier. The payment rule does not apply to Medium enterprises. Additionally, the supplier must have a valid Udyam Registration for the buyer’s expenditure to fall under Section 43B(h).
Thus, buyers must verify MSME registration status, obtain Udyam certificates, and maintain vendor classification records to ensure correct compliance.
            

Section 43B(h) directly ties deductibility of MSME payments with the time limit prescribed under the MSME Act.
If a written agreement exists, the buyer must pay the MSME supplier within the agreed period, which cannot exceed 45 days under the Act. If no written agreement exists, the payment must be made within 15 days. Any payment made after this statutory timeline triggers disallowance under Section 43B(h).
These strict timelines remove ambiguity in payment cycles and ensure that businesses cannot indefinitely negotiate extended credit terms with MSMEs.
            

If the buyer fails to pay the MSME supplier within 15 days or 45 days, as applicable, the related expenditure becomes inadmissible as a deduction for that financial year.
The delayed payment can be claimed as an expense only in the year in which the payment is actually made. This causes a direct increase in taxable income, resulting in a higher tax liability for the buyer. The provision does not allow deduction merely by “accrual”—only payment within the prescribed period qualifies for deduction.
This creates a strong incentive for businesses to prioritize MSME payments ahead of others.
            

Delayed payments to MSMEs lead to an upward adjustment in the buyer’s taxable profits. For example, if a business purchases ₹10 lakhs worth of goods from an MSME and delays payment beyond the allowed period, the entire ₹10 lakhs will be added back to taxable income, even though the expense is recorded in the books.
The net result is that the business pays higher taxes for the year. This not only affects cash flows but also impacts profitability metrics, tax planning strategies, and working capital cycles.
            

Section 43B(h) compels businesses to reorient their vendor payment systems. They can no longer treat MSME dues as flexible credit facilities. Companies must maintain adequate liquidity to settle MSME invoices on time. This affects the buyer’s working capital planning, as priority payments must be made to MSMEs before other creditors.
Businesses with long supply chains or high-volume MSME procurements face increased operational discipline, as delays can cause substantial tax disallowances. The provision pushes businesses to strengthen treasury management and vendor evaluation processes.
            

The burden of identifying MSME status lies solely on the buyer. Businesses must maintain updated lists of registered MSME vendors, collect their Udyam certificates, and assess any change in classification.
Failure to verify correct MSME status may result in unintended tax disallowances or compliance lapses. As MSME classification may change with turnover or investment variations, periodic vendor review becomes essential. Buyers must also ensure that vendors continue to hold valid registration on the transaction date.
            

The rule applies only when goods or services are purchased from registered Micro or Small Enterprises. It does not apply to Medium Enterprises. Additionally, payments classified as capital expenditure do not fall under Section 43B(h), as the provision applies only to revenue expenditure.
Moreover, if the supplier is not registered with Udyam, the payment is not governed by this section. This distinction brings clarity and ensures that only verified MSME suppliers are protected under the payment rule.
            

Section 43B(h) operates independently of GST rules but influences contractual obligations significantly. While GST law governs tax on supply, Section 43B(h) governs the timing of payment for income-tax deduction. As businesses work with MSMEs, they must ensure that invoice dates, contract terms, and GST compliance align with the timelines required under the Income Tax Act.
Businesses must also be cautious about entering long credit period agreements with MSMEs, as any contract exceeding 45 days is invalid for tax purposes, even if agreed mutually.
            

The introduction of Section 43B(h) provides MSMEs with stronger legal backing to ensure timely payments from buyers. With severe tax penalties for delays, buyers are compelled to prioritize MSME dues.
This improves MSMEs’ working capital cycles, eliminates prolonged receivable delays, and enhances their financial stability. The provision also reduces disputes and brings more transparency to business transactions.
            

Businesses must implement robust internal controls to comply with Section 43B(h). Vendor onboarding systems must include MSME classification checks, invoice tracking mechanisms must highlight aging MSME invoices, and finance teams must prioritize payments nearing the statutory deadlines.
Mapping ERP systems to flag MSME transactions, integrating Udyam verification tools, and conducting periodic audits can prevent non-compliance. Additionally, companies must train procurement and finance teams to understand and implement the timelines mandated by the law.
            

Non-compliance results in disallowance of expenses, higher tax outflow, interest liabilities, and increased scrutiny during assessments. Tax authorities can demand proof of timely payments, and failure to furnish documentation may lead to adjustments, penalties, and litigation.
Repeated violations may also affect vendor relationships and reputation, as MSMEs increasingly demand timely payments backed by statutory provisions.
            

Section 43B(h) marks a transformative shift in business payment discipline toward MSMEs. By linking deduction of expenses to timely payment, the law ensures that buyers do not exploit MSME suppliers by delaying payments. This provision strengthens the MSME ecosystem, enhances liquidity, and gives small enterprises the financial protection they need to grow sustainably.
For businesses, compliance requires robust systems, accurate vendor classification, and strict adherence to timelines. While the provision increases operational responsibility for buyers, it ultimately contributes to a healthier, more accountable supply chain environment.
            

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