What is MSME payment rule?

What the rule says

An amount a business owes to a micro or small enterprise is deductible for income tax only in the year it is actually paid, if it is not paid within the time limit in section 15 of the MSMED Act. The usual relief for expenses paid before the income tax return due date does not apply.

The rule was added as section 43B(h) of the Income-tax Act, 1961, from the financial year 2023-24. It continues as section 37(2)(g) of the Income-tax Act, 2025, which applies from the tax year 2026-27.

The time limit

Under section 15 of the MSMED Act, the buyer must pay:

• With a written agreement: by the agreed date, which cannot be later than the maximum period the Act allows, counted from the day the goods or services are accepted (or treated as accepted).
• Without a written agreement: within the shorter period the Act sets for that case, from acceptance.

The periods are set by the Act and can be changed by Parliament, so check the current text of section 15.

The deduction is lost for the year only when the payment is late. An invoice paid within its limit is deductible in the year of purchase, even if the payment falls after the year end.

Who counts as a supplier

• Micro and small enterprises only. Amounts owed to medium enterprises are not covered.
• Generally, suppliers registered on Udyam as micro or small. Ask every supplier for their Udyam certificate, and check its classification each year, because the limits that define micro and small were raised from 1 April 2025.
• Traders. Retail and wholesale traders can register on Udyam, but a July 2021 memorandum from the MSME ministry restricts their benefits to priority sector lending. The widely held view, which this glossary follows, is that the rule does not apply to amounts owed to traders. No official clarification settles the point, and some commentators disagree, so take advice on large balances.

Interest on late payment

A buyer who pays late must also pay the supplier compound interest with monthly rests, at a multiple of the bank rate notified by the RBI that the Act sets, from the date payment fell due. Under section 23 of the MSMED Act, that interest is never deductible for income tax.

Reporting

• Companies file MSME Form 1 with the Registrar of Companies for each half-year in which payments to micro or small enterprises are pending beyond the time limit, by the due date the rules set.
• Financial statements of companies disclose the amounts owed to micro and small enterprises, and the interest due and paid on late payments.
• The tax audit report, for a business that needs one, also covers these amounts.

Making it work in practice

1. Mark micro and small suppliers in the vendor master, with their Udyam number and whether they are manufacturers, service providers or traders.
2. Record the acceptance date for each invoice, not just the invoice date.
3. Put written payment terms within the Act's limit in every supplier agreement. Without them, the shorter limit applies.
4. Run an ageing report of MSME dues every week, and review it before the year end.

The rule also limits how far you can shorten your cash conversion cycle by paying suppliers later. Stretch payments to other suppliers, not to micro and small ones.