Section 43B(h) of the Income Tax Act requires companies to pay Micro and Small Enterprise vendors within 45 days of accepting goods or services (15 days if no written agreement exists). Any amount unpaid at 31 March cannot be deducted in that financial year; the expense shifts to the year of actual payment. The compliance risk sits inside the AP workflow, not the tax return.
Most finance teams heard about Section 43B(h) when it came into effect in April 2024 and handed it to their CA. That was the wrong call. The rule applies to any company in India buying from eligible MSME vendors, creates a direct link between invoice payment timing and tax deductibility, and the data it depends on lives entirely inside the AP function. By the time the tax auditor asks for a schedule of outstanding MSME dues at year-end, it is too late to fix the workflow that created them.
What the rule covers, and what it does not
Section 43B(h) applies when your company purchases goods or services from a vendor registered under the MSMED Act as a Micro or Small enterprise. The buyer's own registration status is irrelevant. A large manufacturer buying from a Udyam-registered fabricator is fully in scope whether or not the manufacturer holds any MSME registration.
Two points narrow the scope in ways that matter for vendor classification. First, Medium enterprises are excluded; the rule applies only to Micro and Small. Second, traders are excluded. A vendor registered as a trader under Udyam does not qualify, even if the business is small. Only manufacturers and service providers registered as Micro or Small are covered under Section 43B(h) compliance requirements.
The payment timeline has two settings. Where no written agreement exists between buyer and vendor, payment is due within 15 days of accepting the goods or services. Where a written agreement does exist, payment must be made within the period specified in the agreement, subject to a hard cap of 45 days. The absence of a contract defaults you to the stricter 15-day window. This catches most informal vendor relationships by surprise.
Where the exposure lives in an AP workflow
If an eligible MSME invoice is unpaid at 31 March, the expense cannot be deducted in that financial year; it becomes deductible only in the year the payment is actually made. Accrual accounting provides no protection. An unpaid MSME liability at year-end is a deferred deduction, not a current-year expense.
Late payment also triggers interest under Section 16 of the MSMED Act. As typically interpreted, interest accrues at three times the RBI repo rate, compounded. At the current repo rate of 5.25%, that works out to 15.75% per annum on the overdue amount. This interest is not deductible as a business expense, making it a permanent cost, not a timing difference.
The practical exposure rarely comes from one large unpaid invoice. It accumulates across dozens of smaller vendor payments sitting in approval queues, waiting on GRN confirmation, or falling into the next payment run after the statutory deadline has passed. A 20-day internal approval cycle combined with a weekly payment run can breach the 15-day window on every invoice where no written agreement is in place.
MSME payment tracking follows the same logic as month-end close cut-offs. If your team already runs a hard cut-off on GST-related AP items before 31 March, MSME payments need the same treatment, with the added complexity that the statutory deadline is not a calendar date but a rolling count from invoice acceptance.
What AP teams need to change operationally
Four changes address the bulk of the exposure.
Classify the vendor master. The starting point is knowing which vendors are in scope. Collect Udyam Registration Certificates from all vendors and tag Micro and Small manufacturers and service providers in your ERP or AP system. Traders and Medium enterprises are out of scope. This is a one-time exercise with an ongoing maintenance requirement, since vendors can register, upgrade their category, or let registration lapse. Udyam certificate status can be verified on the Udyam Registration portal. The vendor compliance lifecycle needs to capture Udyam status as a required onboarding field, not an afterthought.
Set payment age alerts at day 30, not day 45. An alert at the statutory deadline leaves no buffer for approval delays, bank processing, or payment run timing. A day-30 alert on any open MSME invoice gives the AP team time to act. For vendors with no written agreement, the alert threshold should be day 10. Most AP systems can flag invoices by vendor tag; the classification step above is what makes this possible.
Audit your written agreements. For every tagged MSME vendor, confirm whether a written agreement specifying payment terms exists. Where it does not, the 15-day window applies. Vendors governed only by a purchase order may not have a qualifying agreement. This is worth verifying with your legal team before assuming the 45-day cap applies to your informal supply relationships.
Build the Form 3CD audit trail now. As reported by tax practitioners under revised Clause 22 of Form 3CD, applicable from AY 2025-26, AP teams must provide the tax auditor with a schedule covering: total amounts payable to MSEs during the year; the split between timely payments (within 15 or 45 days) and delayed payments; year-end outstanding dues classified by whether they remain disallowable; and interest accrued under Section 16. Prior-year disallowances paid in the current year are separately reported under Clause 26. This data has to come from the AP system. The CA cannot reconstruct it from the trial balance alone.
The compliance picture for AP has become more complex since GST was introduced. Section 43B(h) adds a layer that intersects directly with GST AP compliance requirements, since vendor registration status, invoice timing, and year-end cut-offs affect both.
Key observations
- Section 43B(h) applies to the buyer regardless of the buyer's own MSME or registration status. Any Indian company purchasing from a Udyam-registered Micro or Small manufacturer or service provider is in scope.
- The 15-day window is the default. Without a written agreement specifying payment terms, the stricter deadline applies - and most informal vendor relationships governed by purchase orders do not qualify as written agreements under the rule.
- Late payment interest under Section 16 of the MSMED Act accrues at three times the RBI repo rate, compounded. At the current rate that is 15.75% per annum, and it is not tax-deductible. This makes late payment a permanent cost, not a timing difference.
- The Form 3CD Clause 22 schedule requires data that can only come from the AP system. The CA cannot reconstruct it from the trial balance - MSME payment age, timely vs. delayed splits, and year-end outstanding dues must be tracked at invoice level throughout the year.
- Vendor classification is a maintenance task, not a one-time exercise. Vendors can register under Udyam, change category, or let registration lapse. Udyam status must be a live field in the vendor master, not a historical tag.
AP automation that tags MSME vendors, tracks payment age by invoice, and generates the Clause 22 schedule on demand reduces the manual effort and audit exposure. See how IQInvoice handles MSME payment tracking alongside 3-way matching and ERP posting.
Published by IQInvoice
IQInvoice is an accounts payable automation platform for Indian mid-market finance teams, covering invoice capture, GST compliance validation, approval routing, and ERP integration.