Under Section 43B(h) of the Income-tax Act, if a business has not paid a Micro or Small Enterprise vendor within 15 days — or 45 days where a written agreement specifies that period — that expense is disallowed in the tax computation for the year. This applies even though it's a completely legitimate cost the business fully intends to pay. The deduction only returns in the year the payment is actually made, so a routine delay in settling a vendor becomes an unplanned spike in taxable income. The provision applies specifically to Micro and Small enterprises; Medium enterprises are excluded.
The detail most businesses miss: for most other items covered under Section 43B, paying before your income-tax return filing due date still preserves the deduction for the earlier year. Clause (h) doesn't get that relief. Even if you pay the vendor well before you file your return, the deduction stays locked to the year of actual payment if the 15/45-day MSMED deadline was missed. This is precisely the assumption that trips businesses up — they treat it like every other Section 43B item, and it isn't.
A note on timing: this article uses the Section 43B(h) reference, which governs FY 2025-26 and earlier tax years. Under the Income-tax Act, 2025 (in force from 1 April 2026), the same substantive rule carries forward as Section 37(2)(g) for Tax Year 2026-27 onward — the mechanics are unchanged, only the section number.
Why this catches businesses off guard
Three reasons, and none of them involve bad faith:
- MSME status is not always visible from the invoice. Vendors aren't required to display their Udyam registration on every bill, and businesses rarely cross-check supplier master data against the Udyam portal as a matter of routine.
- Payment terms get set by habit, not by law. A 60-day payment cycle might be standard in your industry and perfectly reasonable commercially — but it does not override the 45-day statutory ceiling for MSME vendors. A written agreement cannot extend the deadline beyond 45 days; anything longer is simply void for this purpose.
- The gap only shows up at tax computation time — by which point the financial year, and the chance to simply pay faster, has already closed.
The cost isn't only in your tax computation
The disallowance under Section 43B(h) sits on top of a separate exposure under the MSMED Act itself: if payment isn't made within the statutory period, the vendor is entitled to compound interest at three times the RBI-notified bank rate, running from the day after the deadline until actual payment. That interest is not tax-deductible either. In practice, a single missed deadline can mean paying tax on an expense you haven't yet deducted *and* accruing a non-deductible interest liability on the same delay — two separate costs from one overlooked payment date.
What this looks like inside an actual internal audit
This is exactly the kind of gap internal audit is built to catch before it becomes a tax filing surprise. In practice, that means:
- Reconciling the vendor master against Udyam registration status, rather than assuming your accounting system already has it tagged correctly
- Running an aging analysis on payables specifically for MSME-flagged vendors, separate from your general payables aging
- Flagging any invoice crossing the 15/45-day threshold while there is still time in the financial year to act — not after
- Quantifying the potential disallowance early, so it's a known number your finance team can plan around rather than a year-end surprise
None of this requires a large audit function or a quarter-long engagement. It requires someone systematically checking a specific thing most day-to-day bookkeeping was never designed to check.
The broader point
This is really what internal audit is for in a business your size — not a once-a-year formality, and not a hunt for wrongdoing. It's a second, deliberately structured look at the mechanics of how money moves through your business, built to catch the gaps between "the books are accurate" and "the tax and compliance consequences are handled." Most of what internal audit finds isn't dramatic. It's exactly this: quiet, procedural, and expensive if nobody is looking for it.