Section 43B(h) Explained: The MSME Payment Rule That Can Wipe Out a Business Tax Deduction

A business that buys raw material from a small manufacturer, books the expense the day the invoice arrives, and then pays the bill two months later runs into a rule that didn't exist before FY 2023-24: Section 43B(h) (now Section 37(2)(g) of the Income-tax Act, 2025) reaches back and disallows that entire expense for the year it was booked, purely because payment came in late. It doesn't matter that the business follows accrual accounting, or that the amount would ordinarily be a perfectly legitimate deduction — the clock that matters here is the MSMED Act's payment deadline, not the accounting method.

What the Rule Actually Says

Section 43B(h), inserted by the Finance Act 2023 and effective from FY 2023-24 (Assessment Year 2024-25) onward, adds one more item to the list of expenses in Section 43B (now Section 37) that are allowed as a deduction only on actual payment, not merely on accrual. What makes clause (h) different from the rest of Section 43B is the deadline it borrows: instead of the usual grace period (Section 37(3) of the 2025 Act, which excludes clause (g)) up to the income tax return's due date, the payment has to be made within the time limit fixed under Section 15 of the MSMED Act, 2006 — 15 days if there's no written agreement with the supplier, or up to 45 days if a written agreement specifies a longer period. Cross the deadline, and the expense is disallowed for that financial year and added back to taxable profit, becoming deductible only in the year the payment is actually made.

Who This Actually Applies To — and Who's Left Out

The rule only bites when the supplier is a registered Micro or Small Enterprise under the MSMED Act — Micro means investment up to ₹2.5 crore and turnover up to ₹10 crore, Small means investment up to ₹25 crore and turnover up to ₹100 crore. Medium enterprises are explicitly excluded from Section 43B(h), even though they're covered elsewhere under MSME classification. A second, commonly missed exclusion: wholesale and retail traders are only eligible for Udyam registration for priority-sector-lending purposes, not for the protections under the MSMED Act's Section 15 — so payments to a trader supplier, even a small one, generally fall outside Section 43B(h)'s reach. In practice, that narrows the rule to manufacturers and service providers who hold a valid Udyam registration as Micro or Small.

The Interest the MSMED Act Also Adds

Missing the payment deadline doesn't just cost the tax deduction for a year — the MSMED Act separately entitles the small enterprise to compound interest at three times the RBI-notified bank rate on the delayed amount, and that interest, if paid, is not itself an allowable business expense under the Income Tax Act. The combined effect is a genuine double cost for chronic late payers: a disallowed deduction plus a non-deductible interest liability, on top of whatever commercial relationship damage results from paying suppliers late.

What Businesses Should Actually Do Before the Financial Year Closes

• Ask every vendor for their Udyam registration certificate and note whether they're classified Micro, Small, Medium, or a trader — only Micro/Small manufacturers and service providers trigger this rule.
• Flag payment terms with MSE suppliers in the accounting system separately, since the 15/45-day clock runs from acceptance of goods or services, not from the invoice date or your own internal approval cycle.
• Where a longer credit period is genuinely needed, get it into a signed written agreement with the supplier before the transaction — this is what unlocks the 45-day limit instead of defaulting to 15 days.
• Reconcile outstanding MSE dues before March 31 each year; anything unpaid at year-end needs to be added back in the tax computation for that year regardless of what the books show.

This sits alongside the other presumptive and business-income provisions that shape how smaller entities compute tax — our guides to Section 44AD for small business and traders and Section 44ADA for freelancers and professionals cover presumptive taxation (both now in Section 58 of the 2025 Act), which sidesteps this issue entirely since profit is computed as a flat percentage of turnover rather than through itemised expense deductions. Businesses filing under the regular provisions, though, need to track this vendor-by-vendor. Our complete ITR filing guide for AY 2026-27 covers where this add-back gets reported in the computation.

The Bottom Line

Section 43B(h) turns a routine vendor-payment delay into a tax cost, not just a relationship problem, and it applies whether or not the business intended to pay late. The fix isn't complicated — identify which suppliers are Micro or Small enterprises, track their specific payment deadlines separately from general accounts payable, and clear those dues before the financial year closes. For any business still treating MSE vendor payments the same as every other creditor, this is the one line item worth auditing before the financial year books close. Numbering: for FY 2025-26 (assessment year 2026-27) the rule is Section 43B(h) of the Income-tax Act, 1961; from FY 2026-27 it is Section 37(2)(g) of the Income-tax Act, 2025, and the return-due-date grace in Section 37(3) expressly leaves clause (g) out.