Section 43B(h) and the September 30, 2026 Tax Audit: The MSME Payment Disallowance Founders Get Wrong (and Its Move to Section 37 of the Income-tax Act 2025)

Practitioner advisory, updated 18 September 2026. The tax audit for FY 2025-26 (Assessment Year 2026-27) is due by 30 September 2026. If your books carry unpaid dues to a micro or small supplier as at 31 March 2026, Section 43B(h) may already have shifted that expense out of the year, and no payment you make now brings it back. This memo explains the rule, the trap most founders miss, how it is reported in the tax audit, and where it moves under the Income-tax Act 2025.

Quick Summary: Section 43B(h) MSME Payment Disallowance for the 2026 Tax Audit

• What it does: Section 43B(h) of the Income-tax Act 1961 allows a deduction for any sum payable to a micro or small enterprise only in the year it is actually paid, if it was outstanding beyond the time limit in Section 15 of the MSMED Act, 2006.
• The trap: For every other item in Section 43B you can pay before the return due date and still claim the deduction. Clause (h) is expressly carved out of that proviso. Paying an MSME supplier in July 2026 does not restore the FY 2025-26 deduction.
• The test date is 31 March. The disallowance bites only on amounts still unpaid at the year-end that were already past the 15 or 45 day limit. Pay before 31 March and the deduction stands.
• Who is covered: Suppliers that are micro or small enterprises. Medium enterprises are outside the clause. The supplier’s status is fixed by its Udyam registration.
• Where it goes next: From FY 2026-27 the same rule sits at Section 37(2)(g) of the Income-tax Act 2025, with the return due date now referenced to Section 263(1).

Why This Matters Before 30 September 2026

The Section 43B(h) MSME payment disallowance is the single line item that turns a routine tax audit into a dispute at the finalisation stage. It was inserted by the Finance Act 2023 and took effect from Assessment Year 2024-25. The FY 2025-26 audit now being finalised is the second full year in which auditors must certify it. Founders who paid their suppliers eventually, but late, are surprised to learn that timing, not the fact of payment, decides the year of deduction. A disallowed expense inflates the taxable profit of FY 2025-26, raises advance-tax and interest exposure under Sections 234B and 234C, and, where the audit is signed on a wrong footing, exposes the auditor as well.

What Section 43B(h) Actually Says

Section 43B is headed “Certain deductions to be only on actual payment.” Clause (h), as it appears on the Income Tax Department’s own record, reads:

“(h) any sum payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006).”

The controlling words sit in the proviso to Section 43B. For most clauses the proviso is a rescue: if you pay on or before the due date for filing your return, the deduction is allowed in the year the liability arose. The proviso reads (emphasis added):

“Provided that nothing contained in this section [except the provisions of clause (h)] shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 …”

Read those two together and the rule is unambiguous. The pay-before-return rescue that applies to statutory dues, interest, bonus and leave encashment does not apply to a micro or small enterprise payable. For MSME dues, the only date that saves the deduction is 31 March.

The 15-Day and 45-Day Clock Under Section 15 of the MSMED Act

Section 43B(h) does not itself set the payment window. It points to Section 15 of the MSMED Act, 2006, which fixes the “appointed day” by which a buyer must pay a micro or small supplier:

• No written agreement: payment is due within 15 days of acceptance or deemed acceptance of the goods or services.
• Written agreement in place: payment is due within the agreed period, but that period can never exceed 45 days, however the contract is worded.

So the outer limit is always 45 days where there is a written agreement, and 15 days where there is not. A 90-day credit term written into a purchase order does not extend the limit for this purpose; it is void to the extent it exceeds 45 days.

The Trap: Paying “Before the Return” Does Not Rescue the MSME Deduction

This is the point founders and finance teams most often get wrong. Consider an invoice of Rs 8,00,000 from a small enterprise, due within 45 days, that was still unpaid on 31 March 2026. You settle it on 10 July 2026, well before your tax-audit return is due. For a normal Section 43B item, that payment would preserve the FY 2025-26 deduction. For Clause (h), it does not. The Rs 8,00,000 is disallowed in FY 2025-26 and becomes deductible only in FY 2026-27, the year of actual payment. The deduction is deferred, not destroyed, but the cash tax for FY 2025-26 is real and immediate.

Worked Examples: When the Disallowance Bites

Scenario (small-enterprise supplier)	Paid?	FY 2025-26 deduction
Invoice due in 45 days, paid on day 40 (before 31 Mar 2026)	Yes, within limit	Allowed in FY 2025-26
Invoice due in 45 days, paid on day 60 but before 31 Mar 2026	Late, but paid by year-end	Allowed in FY 2025-26 (paid before 31 March)
Invoice due in 45 days, unpaid at 31 Mar 2026, paid 10 Jul 2026	Paid after year-end	Disallowed in FY 2025-26; deductible in FY 2026-27
No written agreement, due in 15 days, unpaid at 31 Mar 2026	Unpaid at year-end	Disallowed in FY 2025-26
Supplier is a medium enterprise, unpaid at 31 Mar 2026	Unpaid	Allowed (Clause (h) does not cover medium enterprises)

Who Counts as a Micro or Small Enterprise?

Clause (h) applies only where the supplier is a micro or small enterprise. It does not cover medium enterprises, and it does not cover a supplier who is not registered as a micro or small enterprise on the Udyam portal. Two practical points follow:

• Status is the supplier’s, not yours. The buyer’s size is irrelevant. What matters is whether the person you owe is a micro or small enterprise, evidenced by its Udyam registration number.
• Traders sit in a grey zone. The Ministry allows wholesale and retail traders to obtain Udyam registration, but that registration was extended primarily for priority-sector lending. Whether a pure trader can invoke the Section 15 protection for the 43B(h) disallowance is contested. Where a supplier is a trader, take a considered position and document it rather than assume the disallowance applies automatically.

The workable rule for a busy finance team: collect the Udyam registration number and enterprise classification (micro, small or medium) from every vendor, and flag any micro or small supplier balance outstanding beyond its limit as at 31 March.

How It Is Reported in Your Tax Audit

In the tax audit report, Section 43B sums are reported in Clause 26 of Form 3CD, which distinguishes amounts paid within the year, amounts paid before the return due date, and amounts still outstanding. Because Clause (h) is carved out of the return-due-date rescue, an MSME payable that was outstanding at 31 March cannot be parked in the “paid before due date” column. The auditor must report it as disallowed. This is exactly where a self-prepared draft and a signed audit report diverge, and why founders should reconcile their MSME ageing before the auditor arrives, not after. For the related interest angle under the MSMED Act, the auditor separately reviews the MSME disclosures required in the notes to accounts.

Two connected disallowances catch the same audits every year: the Section 40(a)(ia) disallowance for TDS not deducted or paid late, and the bad-debt write-off test under Section 36(1)(vii). Read together, they cover most of the timing adjustments that surface at finalisation.

What Changes Under the Income-tax Act 2025: Section 37(2)(g)

The Income-tax Act 2025 comes into force from 1 April 2026 and governs FY 2026-27 (tax year 2026-27) onward. The 43B rule is re-homed at Section 37, headed “Certain deductions allowed on actual payment basis only.” Note the numbering trap: this new Section 37 is not the old general-business-deduction Section 37 of the 1961 Act. It is the successor to the old Section 43B.

The MSME item survives as clause (g) of the list, and the carve-out survives with it. On the Department’s record, Section 37 lists at sub-section (2):

“(g) amount payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006).”

And the rescue at sub-section (3) again excludes it:

“(3) In case the amounts specified in sub-section (2), except the sum referred to in clause (g) thereof, are paid after the end of the tax year in which the liability was incurred, but on or before the due date of filing of return of income under section 263(1) for such tax year, the deduction towards such sum shall be allowed in such tax year.”

So nothing of substance changes for MSME dues. Only the labels move: old 43B(h) becomes Section 37(2)(g), and the return due date, formerly Section 139(1), is now Section 263(1). Cite the 1961 Section 43B(h) for FY 2025-26 and earlier, and Section 37(2)(g) of the Income-tax Act 2025 for FY 2026-27 onward.

Compliance Checklist: Close the FY 2025-26 Position Correctly

1. Tag your vendor master. Record each supplier’s Udyam number and classification (micro, small, medium or unregistered).
2. Pull the 31 March 2026 ageing for micro and small suppliers only. Medium and unregistered suppliers are outside Clause (h).
3. Apply the limit: 15 days where there is no written agreement, 45 days where there is. Anything unpaid beyond the limit as at 31 March is a candidate for disallowance.
4. Do not rely on payment before the return. Confirm the balance was cleared on or before 31 March 2026, not merely before the filing date.
5. Quantify the add-back and recompute FY 2025-26 taxable income, advance-tax shortfall and Section 234B and 234C interest.
6. Claim the deduction in FY 2026-27 for amounts paid this year that were disallowed last year, so the expense is not lost twice.
7. Document trader positions. Where a supplier is a pure trader, record the basis on which you did or did not apply the disallowance.

Frequently Asked Questions

Does Section 43B(h) apply if I paid the supplier before filing my return?

No, that rescue does not apply to MSME dues. The proviso to Section 43B expressly excludes clause (h). For an MSME payable, the deduction is preserved only if the amount was paid on or before 31 March of the financial year. Payment after year-end shifts the deduction to the year of payment.

Does the disallowance apply to medium enterprises?

No. Clause (h) covers only micro and small enterprises. A payable to a medium enterprise is not disallowed under Section 43B(h), regardless of how late it is paid.

What is the payment limit if there is no written contract?

Fifteen days from acceptance or deemed acceptance of the goods or services. A written agreement can extend the limit only up to 45 days, never beyond.

Is the disallowed amount lost forever?

No. It is deferred, not denied. The amount disallowed in FY 2025-26 becomes deductible in the year it is actually paid. The cost is the tax and interest on the earlier year’s inflated profit.

Where does this rule sit under the new Income-tax Act 2025?

At Section 37(2)(g), with the same carve-out from the pay-before-return rescue at Section 37(3). The return due date is now referenced to Section 263(1). This applies from FY 2026-27. For the FY 2025-26 audit, continue to cite Section 43B(h) of the 1961 Act.

The Bottom Line

Section 43B(h) rewards one discipline above all: clear your micro and small suppliers within their statutory limit, and in any case before 31 March. For balances that slipped, accept the FY 2025-26 add-back, recover the deduction in FY 2026-27, and make sure the tax audit reflects the position honestly. The rule does not change under the Income-tax Act 2025; only its address does.

Facing a spread of unpaid MSME balances at year-end and unsure of the add-back? Talk to an Expert at Tax Update India for a clear read on your Section 43B(h) exposure before you sign the audit. Book a quick call.

Disclaimer: This article is for general information only and does not constitute legal, tax or professional advice. Statutory provisions are cited from the Income Tax Department record as retrieved on 18 September 2026. Apply the law to your specific facts with a qualified professional before acting. Tax Update India.