India's MSME payment rule creates two separate questions for a buyer: when must a Micro or Small Enterprise be paid, and when can the related business expense be deducted for income-tax purposes? The common mistake is to treat this as a simple 31 March outstanding-payables test. A better approach is invoice-by-invoice: confirm supplier status, establish the acceptance date and credit period, determine the statutory payment deadline, compare the actual payment date with that deadline, and then decide the tax treatment.
For Tax Year 2026-27 onward, the governing income-tax rule is section 37 of the Income-tax Act, 2025. The official Income-tax Act, 2025 text as amended by Finance Act, 2026 states in section 37(2)(g) that an amount payable to a micro or small enterprise beyond the time limit in section 15 of the MSMED Act is covered by the actual-payment rule. Section 37(3) expressly excludes this MSME item from the return-due-date relief available to the other listed payment-basis deductions. The Income Tax Department also provides a dedicated Income-tax Act, 2025 landing page.
Why people still refer to section 43B(h)
Section 43B(h) is the corresponding provision in the Income-tax Act, 1961 and remains relevant for earlier periods. The Income Tax Department's official transition FAQ explains that the 1961 Act continues to govern tax years beginning before 1 April 2026. Income for FY 2025-26 is therefore dealt with under the old Act, while Tax Year 2026-27 is governed by the Income-tax Act, 2025. A working paper should state the relevant year before quoting section 43B(h) or section 37(2)(g).
The 15-day and 45-day payment test
The income-tax provision does not create its own payment clock; it points to section 15 of the Micro, Small and Medium Enterprises Development Act, 2006. The Income Tax Department's official MSME tax-benefits guide explains the practical rule: where there is no written agreement, payment is to be made within 15 days, while a written agreement can provide a period up to a maximum of 45 days. The Ministry of MSME's MSME Samadhaan guidance page confirms that sections 15 to 24 of the MSMED Act deal with delayed payments to Micro and Small Enterprises.
An accounts-payable ageing report is therefore not enough by itself. A 30-day-old invoice may already be late where no written credit arrangement exists, while another invoice may still be within a valid written credit period. The file should capture the acceptance or deemed-acceptance date and the written payment terms instead of measuring everything automatically from the invoice date.
What happens when payment is late?
Section 37 of the 2025 Act follows an actual-payment approach for the specified sums. For the MSME item in section 37(2)(g), the return-filing-due-date relief in section 37(3) does not apply. If an otherwise deductible expense becomes subject to the MSME clause because the statutory payment limit has been breached, the deduction is available in the tax year in which the amount is actually paid; payment merely before the income-tax return due date does not restore the earlier-year deduction.
Do not use 31 March as the first test
A year-end review starts with the statutory due date, not with the closing balance. If an invoice is outstanding on 31 March but its valid section 15 payment period has not expired, the year-end balance alone does not prove a breach. Conversely, an invoice paid before 31 March may have been paid late for MSMED Act purposes; if actual payment still occurs in the same tax year, the actual-payment timing rule may leave the deduction in that year, although separate delayed-payment consequences under the MSMED Act should still be reviewed.
Worked illustration
Assume a business buys services from a qualifying Micro Enterprise under a written agreement allowing payment 30 days from acceptance. First identify the acceptance date and calculate the contractual due date, ensuring the agreed period is within the statutory maximum. If payment occurs within that period, the MSME late-payment tax rule is not triggered merely because the invoice was outstanding at an intermediate date.
If instead the payment is made after the permitted period and after the end of the tax year, the buyer should identify the amount as an overdue MSE payable for tax purposes and, subject to the expense otherwise being deductible, claim it in the tax year of actual payment. Paying it before the return due date does not restore the earlier-year deduction under section 37(3), because that relief excludes section 37(2)(g).
Invoice-level year-end checklist
- Identify qualifying suppliers: maintain evidence that the supplier is a Micro or Small Enterprise rather than relying only on a vendor-master label.
- Capture acceptance data: retain the acceptance or deemed-acceptance date and supporting evidence.
- Capture written credit terms: distinguish invoices with a written payment agreement from those without one and flag any period beyond the statutory maximum.
- Calculate the statutory due date: apply the 15-day or valid agreed-period test instead of one standard ageing bucket.
- Map actual payment dates: reconcile bank payments and vendor-ledger clearing to the relevant invoices or payables.
- Separate timely and overdue amounts: do not treat every year-end MSE balance as disallowable.
- Prepare and roll forward the tax adjustment: track overdue amounts to actual payment and link later claims to the prior-year disallowance so the expense is not deducted twice.
Common mistakes
- Using invoice date as the payment clock without documenting acceptance or deemed acceptance.
- Applying a blanket 45-day rule even where there is no written agreement.
- Adding back every MSE balance outstanding on 31 March without checking whether the statutory payment deadline has expired.
- Assuming payment before the income-tax return due date cures an overdue MSE payable.
- Using section 43B(h) for Tax Year 2026-27 without noting the move to section 37(2)(g) of the Income-tax Act, 2025.
Practical takeaway
The MSME tax deduction rule is best controlled at invoice level. First determine whether the supplier is a qualifying Micro or Small Enterprise, then establish the acceptance date, written credit period and section 15 deadline, and finally compare that deadline with actual payment. For FY 2025-26 and earlier periods use the applicable section 43B(h) framework; for Tax Year 2026-27 onward use section 37(2)(g) of the Income-tax Act, 2025. The decisive tax question is not simply whether money was outstanding at year-end, but whether the statutory payment limit was breached and, if so, in which tax year actual payment occurred.
