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Rishabh Gandhi & Rashi Batra – [2025] 175 taxmann.com 232 (Article)

The Micro, Small, and Medium Enterprises (MSME) sector plays a pivotal role in India’s economic growth, contributing significantly to the GDP (~30%), exports (~45%) and employment (~INR 24.4 crores). Recognised as the backbone of entrepreneurial development, MSMEs have received heightened attention in recent years, particularly under the government’s Aatmanirbhar Bharat Abhiyaan.

MSMEs are categorised based on their investment in plant and machinery or equipment (PME) and their annual turnover. While the original framework was established under the MSMED Act, 2006, recent amendments in the Union Budget 2025–26 have expanded the thresholds to accommodate growing enterprises and widen the scope of benefits.

This reclassification is aimed at ensuring that a larger number of businesses can qualify for MSME support schemes, thereby enhancing access to credit, incentives, and compliance relaxations:

Enterprise Category	Investment Limit	Annual Turnover Limit
Micro	Up to INR 2.50 crores	Up to INR 10 crore
Small	Up to INR 25 crore	Up to INR 100 crore
Medium	Up to INR 125 crore	Up to INR 500 crore

The reclassification aims at bringing more setups under the MSME ecosystem. However, MSMEs continue to grapple with a complex web of tax regulations and compliance requirements that often hinder their growth and formalization. This article delves into the evolving on-ground tax and regulatory challenges from both the buyer’s and MSME’s perspective

Buyer’s perspective – disallowances, disclosures & dilemmas

1. Section 43B(h)

Section 43B(h), introduced by the Finance Act, 2023 and effective from Assessment Year (AY) 2024–25, serves as a significant tax deterrent by disallowing delayed payments to micro and small enterprises (MSEs). This provision refers to Section 15 of the MSMED Act, which mandates that buyers must make payments to MSEs within 15 days, or, in any other case, within 45 days.

From AY 2024–25, any payment to a MSEs beyond the 15/45-day limit has the following tax implications:

Disallowance – Such delayed payments result in disallowance of the corresponding expense as a business deduction in the year in which it is accrued. The expense can only be claimed as a deduction in the year when the actual payment is made, thereby increasing the taxable profits of the assessee in the year of accrual.
Interest liability under Section 16 of the MSMED Act – The delayed payment may attract interest liability under Section 16 of the MSMED Act, calculated at three times the bank rate notified by RBI. It is important to note that this interest expense is not allowable as a deduction under the Income Tax Act.

2. TAR disclosure requirement (Clause 22 and 26 of Form 3CD)

Suppliers dealing with MSMEs now face stricter transparency norms in their TAR due to key amendments in Clauses 22 and 26 of Form 3CD. These revisions mandate disclosures to enforce timely payments and boost MSME protections under the MSMED Act.

Clause 22 – Enhanced MSME payment reporting

Clause 22 was significantly updated for AY 2025–26 to include granular reporting of MSME transactions. The required disclosures include the following:

Total amount payable during the year

Amounts paid within the time specified under Section 15 of the MSMED Act

Amounts not paid within the specified time and deemed inadmissible under Section 43B(h)

Interest not claimable as a deduction under Section 23 due to delayed payments

Clause 26 – Modification in disallowances under Section 43B

A new sub-clause (h) has been introduced to Clause 26, aligning with the amendments in Section 43B, which now explicitly requires reporting of disallowable expenses under Section 43B(h), emphasizing audit scrutiny on MSME payment timelines. This ensures that delayed payments to MSMEs are appropriately reported and disallowed if not paid within the prescribed time.

3. Book of accounts – disclosure requirement

Disclosing unpaid amounts to MSMEs in the books of accounts has become a crucial compliance requirement, enhancing transparency and accountability for businesses. As per Section 22 of the MSMED Act, companies are mandated to report all outstanding dues to MSMEs, detailing both the principal and interest amounts paid or remaining unpaid during each accounting year. This disclosure goes beyond routine bookkeeping—it acts as a legal safeguard directly linked to tax consequences under Section 43B(h) and potential interest liabilities under Section 16 of the MSMED Act. By embedding these disclosures in their financial records, businesses ensure compliance with statutory payment timelines and reinforce fair treatment of MSMEs.

4. Lack of automated MSME verification system

Despite the critical importance of timely payments to MSMEs, businesses face significant operational challenges in ensuring compliance. A major hurdle is the absence of any official PAN-based search functionality or seamless integration between the Udyam Registration Portal and the Income Tax Department’s systems. Without an automated way to verify the MSME status of suppliers using their PAN or Udyam registration number, buyers struggle to accurately identify and track MSME vendors. This gap complicates monitoring payment timelines and compliance, especially for large organisations managing numerous suppliers, increasing the risk of delayed payments and associated tax consequences.

5. Amount retained – pendency of contractual obligations

An additional nuanced aspect pertains to amounts withheld by the supplier as retention money to ensure the satisfactory completion of pending contractual obligations. Since these sums are not yet accrued but contingent upon future performance or successful completion of milestones, they arguably should not be classified as outstanding payments and thus not subject to disallowance under Section 43B(h). Nevertheless, due to the lack of explicit formal clarification on this issue, the treatment remains ambiguous, posing challenges and added complexity for both taxpayers and auditors during compliance evaluations.

6. GST’s role in Section 43B(h)

Although a previous CBDT circular specifically excludes the GST component from tax withholding calculations, this exclusion does not automatically apply to Section 43B(h) disallowances. Section 43B(h) refers broadly to “any sum payable,” which encompasses the entire amount due to MSEs, including GST. Since MSMEs are required to remit the GST collected to the government within prescribed timelines, delays in receiving payments—even the GST portion—can adversely impact their cash flow. Moreover, Section 15 of the MSMED Act uses the term “payment therefor,” strongly suggesting that the GST component is covered under the Act’s payment and protection provisions.