MSMEs under Income Tax: Where Compliance Meets Cash Flow

For decades, the MSME sector has been tax policy’s favourite supporter: celebrated in Budget speeches, courted with concessional regimes, and yet burdened by compliance that often outweighs its resources. Tax Year 2026-27 is the first to be governed by the Income-tax Act, 2025, and it finds MSMEs wearing two hats at once. As taxpayers, they are offered a simplified presumptive route. As suppliers and buyers, they sit at the center of a provision that converts a commercial payment norm into a tax disallowance. For practitioners, the two together make MSME advisory a year-round exercise rather than a March ritual.

Who is an MSME for tax purposes?

The income-tax law does not define an MSME; it borrows the classification from the MSMED Act, 2006. Since 1 April 2025, the revised thresholds apply:

Micro: investment up to ₹2.5 crore and turnover up to ₹10 crore

Small: investment up to ₹25 crore and turnover up to ₹100 crore

Medium: investment up to ₹125 crore and turnover up to ₹500 crore

Classification is computed on the Udyam portal using data linked to PAN, GSTIN and income-tax returns, which means the tax return a client files today quietly decide the category it is placed in tomorrow.      

The distinction is not academic. The provision that matters most in practice, section 43B(h), reaches only micro and small suppliers. A medium enterprise, however modest it may look on the ground, is outside its protection, and an unregistered one is outside it altogether. Registration, not size, is the operative fact.

Section 43B(h), now section 37(2)(g): the clause that moved from the Act to the cash book

Inserted by the Finance Act, 2023 and operative from AY 2024-25, section 43B(h) allows a deduction for sums payable to a micro or small enterprise only on actual payment if the payment is delayed beyond the time limit under section 15 of the MSMED Act: the agreed period, not exceeding 45 days, or 15 days where there is no written agreement. Under the Income-tax Act, 2025, the same rule resides at section 37(2)(g), and the Ministry of Finance, in a Parliamentary reply on 21 July 2026, reiterated that the deduction is linked to actual payment and not to the incurring of the liability.

Three features make this clause unusually unforgiving. First, unlike taxes, duties and similar items in the rest of section 43B, payment before the due date of the return does not rescue the deduction. The test is the statutory window, not the year-end. Second, the clock starts from the date of acceptance (or deemed acceptance) of goods or services, not the invoice date, and a written objection within 15 days defers it until the objection is removed. Third, it is a timing difference and not a permanent disallowance: the amount is allowed in the year of payment. That is cold comfort to a client who has already paid advance tax on a profit inflated by a March payable.

The issues that actually reach us at the desk are fairly predictable:

• Traders: Udyam registration was opened to retail and wholesale traders by a 2021 Office Memorandum, but only for priority-sector lending. The prevailing view is that traders are not “suppliers” under the MSMED Act and therefore fall outside the clause. The view is widely held but not free from doubt, so the basis should be documented rather than assumed.
• Date of registration: A supplier that registers mid-year is generally covered only for supplies on or after the date of registration. The certificate, and not merely the number printed on the invoice, should be checked.
• Udyam Assist and capital purchases: Informal-sector certificates warrant a cautious reading, while capital expenditure, where the claim is depreciation and not a revenue deduction, is not caught.
• Interest: Compound interest payable to an MSE for delayed payment under the MSMED Act is not deductible, so a late payment can cost the buyer twice.
• Disclosure: The consequences now travel beyond the computation of income, into tax audit reporting and, for companies, the half-yearly MSME Form 1 for dues outstanding beyond 45 days.

The interesting point of principle is that this is among the rare instances where an income-tax deduction is conditioned on compliance with a non-tax statute. It is also reinforced by a faster remedy for the supplier: since 15 October 2025, delayed-payment complaints are to be filed on the new MSME Online Dispute Resolution portal, which replaced Samadhaan. Buyers who once treated MSME creditors as the most patient lenders in the balance sheet should expect that patience to be tested.

Practical issues in implementation

Beyond the legal questions, much of the difficulty with 43B(h) is operational. Six situations recur in practice:

• Agreements that stretch beyond 45 days: A written agreement cannot extend the credit period past 45 days for this purpose. Contracts that allow 60 or 90 days do not help the buyer, because the statutory clock still runs at 45.
• Year-end accruals: Provisions for goods received but not invoiced, retention money and disputed bills are where the acceptance date usually goes missing. Without a goods receipt note or a dated written objection, the safer assumption is acceptance on delivery.
• Set-offs and part payments: Whether an adjustment against amounts receivable from the same vendor counts as “actual payment” is a point on which practitioners differ. Settling through banking channels, with a clear narration, removes the doubt.
• Cash paid to beat the deadline: A hurried cash payment in March can trade one disallowance for another under section 40A(3) if it crosses the prescribed limit.
• The buyer may itself be an MSME: The clause binds every buyer, whatever its size. A small client buying from other small units is exposed, unless it is taxed under section 58, where no expense is claimed.
• Advance tax and tracking: An add-back raises taxable income and can trigger interest for short payment of advance tax, so the likely disallowance should be estimated before the year closes. A register of amounts added back, claimed in the year of actual payment, prevents the deduction from being missed.

Section 58: the simpler way to pay tax

Section 58 is the relief side of MSME taxation. A small business using it pays tax on a fixed percentage of turnover, so it needs no detailed books and has no expenses to disallow under 43B(h). It depends on turnover, type of business and digital receipts, not on Udyam category, so a business can be an MSME and still not qualify. The Income-tax Act, 2025 combines the old sections 44AD, 44ADA and 44AE into this one section. The rates are the same; only the layout is new.

Feature	Income-tax Act, 1961	Income-tax Act, 2025
Provisions	44AD, 44ADA, 44AE	Section 58 (statutory table)
Business income	6% / 8% of turnover	Continues
Specified professions	50% of gross receipts	Continues
Books and audit rules on opting out	44AA, 44AB	Section 62 and corresponding provisions

The rates (6% or 8% of turnover for business, 50% of receipts for specified professionals) and the limits (₹3 crore and ₹75 lakh, where cash receipts are within 5%) continue. Commentators point out a few points to watch:

• Eligibility is now tested for the taxpayer as a whole, not transaction by transaction.
• Partner salary and interest cannot be deducted, and old losses cannot be set off.
• Advance tax is due in one instalment by 15 March.
• Leaving the scheme within the five-year lock-in brings audit and a waiting period.

Because these points rest on the wording of the section, read the section itself before advising a client.

One common mistake: presumptive taxation fixes the profit, not the source of the money. The Tribunal has upheld additions for large unexplained cash deposits even where the taxpayer had offered income under section 44AD.

Which route should a client take?

Sections 43B(h) and 58 lead to one question: regular books or presumptive taxation?

Regular books allow deductions and loss set-off, but bring 43B(h) exposure, tax audit (turnover above ₹1 crore, or ₹10 crore if cash receipts and payments are within 5%) and the cash-payment disallowance. Section 58 gives simplicity but removes deductions and carries the five-year lock-in and the March advance-tax payment.

The form of the business matters too. A domestic company can choose the 22% concessional rate (the special manufacturing regime is closed to new companies). Individual owners are in the new tax regime by default.

Budget 2026 brought stability rather than new relief. Tax slabs and, reportedly, the presumptive limits were left unchanged. The focus was on a smooth move to the new Act, turning some technical-default penalties into fees, and decriminalizing minor defaults. The advice is to choose the route carefully, note the reasons, and not wait for new relief.

Advisory takeaways

The practical lesson is that MSME tax compliance has migrated from the year-end to the sub-ledger. A vendor master that records Udyam number, category, activity and date of registration; a recorded date of acceptance for each invoice; a monthly ageing against the 15/45-day window; and a conscious, documented choice between presumptive and regular books together will resolve most of the disputes before they arise. The profession’s opportunity is to be seen not merely as the preparer of the return but as the architect of the payment calendar. In short, for the MSME the question is no longer only “what is my profit?” but also “when did I pay, and to whom?”

[The author can be reached at amichheda0971.ac@gmail.com]