Tax & ITR

Reporting MSME Dues in the Tax Audit Report: Clause 22 of Form 3CD and Section 43B(h)

By CA Anuj Negi, ACA · Startup Advisory, Saket, New Delhi · Updated 23 September 2026

Four obligations that get conflated — and should not be

Almost every MSME reporting error we see in review starts as a definitional mix-up. There are four distinct requirements, under three different statutes, drawing on one set of vendor data:

A business can be caught by the first and third and not the fourth (an LLP), or by all four (a private limited company under audit). The tax audit report is where the first two meet, which is why Clause 22 is the clause that attracts scrutiny.

The law, in one page

Section 43B(h) of the Income-tax Act, 1961

Inserted by the Finance Act, 2023 and operative from assessment year 2024‑25, clause (h) brings within Section 43B:

The consequence of falling into Section 43B is that the deduction, though otherwise allowable, is allowed only in the previous year in which the sum is actually paid.

The part that makes clause (h) different

Every other clause of Section 43B has an escape hatch: the first proviso allows the deduction on the accrual basis if the payment is made on or before the due date for furnishing the return under Section 139(1). Clause (h) is carved out of that proviso. This is not a matter of commentary — Form 3CD itself now records it. Clause 26(B) reads:

Section 15 of the MSMED Act, 2006 — the clock

Section 15 obliges a buyer to pay the supplier on or before the date agreed in writing, and where there is no such agreement, before the appointed day. Two hard limits follow:

• No written agreement: the appointed day is the day immediately following the expiry of 15 days from the day of acceptance or deemed acceptance.
• Written agreement: the agreed period governs, but it can in no case exceed 45 days from the day of acceptance or deemed acceptance.

Note what the clock does not run from. It does not run from the invoice date, the GRN posting date, or the date the accounts team booked the entry. It runs from acceptance — the actual delivery of goods or rendering of services — or from deemed acceptance, where the buyer raised a written objection within 15 days of delivery and the clock restarts when that objection is removed.

Clause 22 of Form 3CD as it now reads

Clause 22 was substituted with effect from 1 April 2025 by the Income-tax (Eighth Amendment) Rules, 2025 (CBDT Notification No. 23/2025 dated 28 March 2025). It now reads:

How it got here

The direction of travel is unmistakable. The department is no longer content with the disallowance figure; it wants the denominator. Sub-clause (ii) hands the Assessing Officer the entire micro and small enterprise spend for the year, against which the disallowance in (iii)(b) can be sanity-checked.

What goes into each sub-clause

A worked example

A manufacturer buys from three Udyam-registered micro suppliers. There is no written payment agreement with any of them, so the 15-day rule applies.

Clause 22(ii) is ₹18,00,000. Clause 22(iii)(b) is ₹3,00,000 — invoice D alone. Invoice C is the one people get wrong: a year-end creditor is not automatically a disallowance. If the Section 15 window is still open on 31 March, nothing is inadmissible for that year.

The reconciliation gap in Clause 22 — and how to handle it

Look again at the example. Sub-clause (iii)(a) captures invoice A. Sub-clause (iii)(b) captures invoice D. Invoice B — paid late, but paid within the previous year — fits neither description: it was not “paid up to time given under section 15”, and it is not “inadmissible for the previous year”. Invoice C, paid after the year end but inside the window, is similarly homeless.

The form as drafted therefore does not force (ii) to equal (iii)(a) + (iii)(b), and the e-filing utility does not enforce that arithmetic. Our working position, which we document in every file:

• Report (iii)(a) and (iii)(b) strictly on the words of the clause.
• Maintain a third bucket in the working papers — paid beyond the Section 15 window but within the previous year, or unpaid at year end with the window still open — and reconcile it to sub-clause (ii).
• Where the gap is material, add a remark in Form 3CB (or the Form 3CA annexure) explaining the composition of (ii), rather than forcing the two sub-clauses to add up.

Who is covered on the buyer’s side

Section 43B(h) attaches to the assessee claiming the deduction. That means:

• Every form of entity — company, LLP, partnership firm, proprietorship, AOP, trust or society — computing income under the head profits and gains of business or profession on the mercantile basis.
• Whether or not there is a tax audit. This is widely misunderstood. The disallowance is a charging provision in the Income-tax Act; it applies to a small trader with a ₹40 lakh turnover exactly as it applies to a ₹400 crore company. Tax audit only determines whether the reporting in Clause 22 is triggered.
• Whatever the nature of the purchase — raw material, stores, job work, professional services, freight, repairs — so long as the amount is claimed as a deduction in computing business income.

Who counts as a “micro or small enterprise” supplier

This is where the work actually is. Three tests must all be satisfied on the date of the transaction.

Test 1: The size thresholds — revised from 1 April 2025

The Ministry of MSME revised the classification criteria by notification S.O. 1364(E) dated 21 March 2025, effective 1 April 2025. Both conditions — investment and turnover — must be met:

Test 2: Udyam registration

Section 15 casts its obligation in favour of a supplier, and Section 2(n) of the MSMED Act defines a supplier as a micro or small enterprise that has filed a memorandum — in current terms, holds a Udyam registration. The prevailing professional position is therefore that an unregistered enterprise, however small, is not covered. Practically, the auditor looks for the Udyam number on the invoice or obtains a written confirmation from the vendor. An enterprise that obtained Udyam registration mid-year is covered only for transactions on or after the date of registration.

Test 3: Manufacturer or service provider — not a trader

Retail and wholesale trades were allowed onto the Udyam portal in 2021, which has caused a great deal of confusion. The Ministry of MSME’s Office Memorandum dated 2 July 2021 restricts the benefit available to them to priority sector lending only, and expressly excludes other benefits including the delayed payment provisions of the MSMED Act. A trading enterprise holding a Udyam certificate is therefore not a “supplier” for Section 15, and dues to it do not attract Section 43B(h).

Who is outside the net

What failure actually costs

1. The tax on the disallowance

Take a private limited company taxed under Section 115BAA at an effective 25.168% (22% plus 10% surcharge plus 4% cess), with ₹40 lakh of micro and small enterprise dues unpaid beyond the window at 31 March 2026. The disallowance adds ₹40,00,000 to taxable income and roughly ₹10.07 lakh to the tax bill for AY 2026‑27. That money is not lost — it returns as a deduction in the year of payment — but it is paid a year early, out of working capital the business had already deployed elsewhere.

2. Interest under Sections 234B and 234C

Because the disallowance changes assessed income, advance tax instalments were short. Interest under Section 234B and 234C runs at 1% per month on the shortfall. On the illustration above, a company that did not anticipate the disallowance in its advance tax is looking at a further six-figure interest cost. This part is a genuine, unrecoverable loss.

3. MSMED interest at three times the Bank Rate — permanently disallowed

Section 16 of the MSMED Act makes the buyer liable, notwithstanding any agreement to the contrary, to compound interest with monthly rests at three times the Bank Rate notified by the Reserve Bank, from the appointed day or the agreed date. With the Bank Rate at 5.50% (RBI, as on 22 September 2026), that is 16.50% per annum, compounded monthly — an effective annual rate above 17.8%.

Section 23 of the MSMED Act then provides that this interest, whether payable or paid, is not allowed as a deduction in computing income under the Income-tax Act. Unlike the principal, this is a permanent disallowance — it never comes back. It is reported in Clause 22(i).

4. Assessment and penalty exposure

Clause 22 is now a structured, machine-readable field. A Clause 22(iii)(b) figure that does not appear as a disallowance in the computation is an arithmetic mismatch that automated processing under Section 143(1)(a) can pick up without any human reading the file. Where the addition is sustained in assessment and the amount was not disclosed, penalty under Section 270A for under-reporting (50% of the tax on the under-reported income) becomes live.

5. The auditor’s own exposure

Section 271J provides a penalty of ₹10,000 for each report in which an accountant furnishes incorrect information. A Clause 22 reported as “Nil” on nothing more than a client’s verbal assurance, in a business with an obvious micro and small vendor base, is not a defensible position.

What the auditor is actually expected to do

The ICAI’s guidance is clear that identifying which vendors are micro or small enterprises is the auditee’s responsibility, not the auditor’s. That does not reduce the auditor to a post box. A defensible Clause 22 file contains:

• A vendor-wise list from management, flagging MSE status, Udyam number, category (micro/small/medium) and activity (manufacturing/service/trading).
• Verification of Udyam certificates for the significant creditors — not just the numbers, but the classification and activity on the certificate.
• Evidence of the payment terms in writing where the 45-day limit is being relied on. Absent a written agreement, the limit is 15 days, not 45. This is the most common single error in MSME workings.
• An invoice-level computation from the date of acceptance — not the invoice date — to the payment date, for the year-end MSE creditors at minimum.
• A cross-check of Clause 22 against the Section 22 MSMED note in the financial statements and, for companies, against the MSME-1 returns filed for the two half-years. Three numbers from one dataset should agree.
• A specific management representation covering completeness of the MSE vendor list and the payment terms relied on.
• Where the information is unavailable or incomplete, a qualification — in Form 3CB or in the Form 3CA observations — rather than a “Nil”.

The related compliances that should reconcile

Section 22 of the MSMED Act requires a buyer whose accounts are audited under any law to disclose, in the annual statements, the principal and interest due and remaining unpaid at the year end, the interest paid along with payments made beyond the appointed day, the interest due and payable for the period of delay, the interest accrued and remaining unpaid, and the further interest remaining due in succeeding years. Schedule III of the Companies Act carries the same requirement into the notes for companies.

Form MSME-1 is a half-yearly return by specified companies to the MCA, due 31 October for April–September and 30 April for October–March. Following the Specified Companies (Furnishing of information about payment to micro and small enterprise suppliers) Amendment Order, 2024 dated 15 July 2024, the return now captures amounts paid within 45 days, amounts paid after 45 days and amounts outstanding — so a company that cleared its delays before the half-year end must still file. Default attracts penalty under Section 405(4) of the Companies Act, 2013: ₹20,000 on the company and each officer in default, with a continuing penalty of ₹1,000 per day subject to a maximum of ₹3,00,000.

Grey areas that are still unsettled

On each of these, the defensible answer is not a confident one — it is a documented one. An assessing officer can disagree with a position that is reasoned and disclosed. A position that is neither is much harder to defend three years later.

Your FY 2025-26 checklist

1. Extract the creditors ledger for the full year, not just the 31 March balances.
2. Obtain or refresh Udyam certificates for every vendor of significance — the 1 April 2025 limits may have reclassified some of them into “small”.
3. Strip out medium enterprises, traders and unregistered vendors. Document why each was excluded.
4. For the survivors, identify whether a written payment agreement exists. No agreement means 15 days.
5. Compute the due date invoice by invoice from the date of acceptance.
6. Split into the four buckets: paid in time; paid late within the year; unpaid with window still open; unpaid with window expired. The last bucket is Clause 22(iii)(b) and the 43B(h) disallowance.
7. Compute the Section 16 interest on the delays and report it in Clause 22(i).
8. Reconcile against the Section 22 MSMED note and both MSME-1 filings.
9. Carry the disallowance into the computation — and check that the prior year’s disallowance, if paid this year, has been claimed back through Clause 26(A)(a).
10. File Form 3CA/3CB and 3CD by 21 October 2026 (extended from 30 September by CBDT on 28 September 2026).

What changes under the Income-tax Act, 2025

The Income-tax Act, 2025 comes into force on 1 April 2026 and applies from tax year 2026‑27. The audit for FY 2025‑26 (AY 2026‑27) is still governed by the Income-tax Act, 1961 and the Form 3CD discussed above — the Income Tax Department has confirmed that returns for AY 2026‑27 are filed under the old Act’s forms. The substance of the MSME provision carries forward into the new Act; the section numbering does not. Because published mappings of old to new section numbers still conflict on several provisions, we do not quote a new section number here — use the Income Tax Department’s official section mapping utility, and see our note on the old versus new section numbering.