MSME Payment Disallowance

In short

• The rule. If you pay a micro or small enterprise supplier later than the MSMED Act allows, you can claim the expense only in the year you actually pay it. A bill unpaid past its due date at year end is added back to your profit for that year.
• Where it is in the law. For FY 2025-26 and earlier it is section 43B(h) of the Income-tax Act, 1961. From tax year 2026-27 it is section 37(2)(g) of the Income-tax Act, 2025. The rule this site uses is in the box below.
• How it surfaces. Usually through the tax audit report, a query during assessment, or a mismatch in the return.
• The fix. Make the supplier's Udyam status part of vendor onboarding, and track bills against the MSMED Act due date, not your usual credit terms.

The law behind it

Which suppliers are covered. The rule applies to suppliers that are micro or small enterprises under the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act). In practice, that means suppliers registered on the Udyam portal as micro or small. Medium enterprises are not covered.

Traders. Retail and wholesale traders can register on Udyam. However, the MSME Ministry's office memoranda of 2021 limited their benefit to priority-sector lending. Treat a trader's Udyam certificate with care; this site's treatment is in the box below.

The due date to pay. Section 15 of the MSMED Act sets it:

• If you have a written agreement, you must pay by the agreed date. The agreed date cannot be later than the maximum the Act allows.
• If you have no written agreement, a shorter period applies.
• Both periods run from the day you accept the goods or services. If you do not raise an objection, the day of delivery counts as acceptance (this is called "deemed acceptance").
• The day counts this site uses are in the box below.

Interest on late payment. Section 16 of the MSMED Act makes you liable for compound interest, with monthly rests, at three times the bank rate notified by the RBI. Section 23 says this interest is not deductible for income tax.

The income-tax rule. The income-tax provision allows the expense only in the year of payment where payment is made after the time in section 15. The usual relief for other year-end dues does not apply here. That relief allows a deduction when the amount is paid by the return due date.

Bills unpaid at year end but paid on time. These are generally accepted as deductible in the year the expense was incurred.

Why ecommerce brands receive it

Many of an ecommerce brand's regular vendors are micro or small enterprises:

• contract manufacturers and co-packers;
• packaging and printing suppliers;
• photographers and content studios;
• small logistics and warehousing partners;
• freelancers who run as proprietorships.

Brands often pay them on "net 60" or "after the marketplace settles" terms. For a micro or small supplier, those terms can be longer than the Act allows. Year-end, when cash is tight, is when such bills are most likely to be open.

Step-by-step: when the question is raised

1. List the suppliers in question. Use your vendor master and the query itself. For each supplier, note their Udyam number, their classification, and the date of their Udyam registration. Registration made after the invoice date affects whether the invoice is covered.
2. Work out the due date for each bill. Start from the date you accepted, or were deemed to accept, the goods or services. Apply the agreement period or the no-agreement period, using the written agreement where there is one.
3. Compare each bill with its payment date. Sort bills into three groups:
   • paid by the due date;
   • unpaid at year end and paid by the due date;
   • paid late, or still unpaid after the due date. Only the last group is disallowed for the year.
4. Check the exclusions.
   • Are any suppliers traders, outside the delayed-payment protection?
   • Are any medium enterprises?
   • Are any bills for capital items, which are not deducted as an expense anyway?
5. Prepare the computation. Add back the late group, then claim it as a deduction in the year you pay. Make sure the same bill is not added back twice across two years.
6. Reply with the schedule. Quote the supplier, the Udyam classification, the acceptance date, the due date, the payment date and the treatment for each bill.

Documents to gather

• The vendor master, with Udyam certificates and their classification and registration dates.
• Written agreements or purchase orders showing the agreed payment terms.
• Goods receipt notes or service acceptance records, which give the acceptance dates.
• The payables ageing at year end, and bank statements showing the payment dates.
• The tax audit report's MSME disclosure for the year. For FY 2025-26 this is in Form 3CD. From tax year 2026-27, the tax audit report moves to a new form under the Income-tax Rules, 2026.

How to word the reply

The schedule attached lists all creditors registered as micro or small enterprises on the dates of supply. Of the dues outstanding at year end, [amount] was paid within the time under section 15 of the MSMED Act and is deductible this year. [Amount] was paid after that time and has been added back in the computation; it will be claimed in the year of payment. Suppliers [names] are registered as traders, or as medium enterprises, and are outside the provision; their Udyam certificates are attached.

Common mistakes

• Treating every Udyam-registered supplier the same. Medium enterprises, and traders as described above, are treated differently.
• Counting from the invoice date. The Act counts from the day of acceptance or deemed acceptance.
• Assuming a longer written agreement extends the deadline. An agreed period longer than the Act's maximum does not extend it.
• Paying after year end but before filing the return, and treating that as enough. The test is payment within the MSMED Act time, not before the return due date.
• Ignoring section 16 interest. It is payable to the supplier even if the income-tax add-back is reversed later, and it is never deductible.

Preventing it next time

• Onboard vendors properly. Collect the Udyam certificate at onboarding, record the classification in the vendor master, and re-check it every year.
• Track the right due date. Track MSME bills against their MSMED Act due date, and pay them first when cash is short.
• Review MSME dues every quarter. In the last quarter of the year, clear the ones near their due date before year end.
• Companies have an extra filing. They file a half-yearly return of dues outstanding to micro and small suppliers with the Registrar of Companies, so keep the same data ready.

When to take professional help

Take help when:

• the add-back is large;
• the supplier classification is disputed;
• a supplier has filed a delayed-payment claim before the Micro and Small Enterprises Facilitation Council. A claim of that kind brings interest, and it is decided under the MSMED Act, separately from income tax.