MSME Vendor Payments: The Procurement Control With a Tax Price Tag

Most owner-managed businesses treat payables as a cash lever. When collections slow down, payments to smaller vendors get stretched to sixty or ninety days. For years that carried no consequence beyond an irritated supplier. It now carries a tax cost, and it usually surfaces at the worst possible moment - during the tax audit, after the year has closed.

Two laws, one clock

The MSMED Act, 2006 has always set the deadline. Section 15 requires a buyer to pay a micro or small supplier by the date agreed in writing and, in any case, no later than 45 days from the day the goods or services were accepted. Where there is no written agreement, the limit is 15 days. Section 16 then attaches compound interest, with monthly rests, at three times the RBI bank rate, and that interest is not allowed as a deduction for income tax.

What changed is enforcement. Section 43B(h) of the Income-tax Act, 1961, effective from FY 2023-24, allows the expense only in the year the payment is actually made if it misses the statutory window. Rs 4 crore still outstanding to micro and small vendors on 31 March is Rs 4 crore added back to taxable income for that year.

MSME vendor payments fail in the vendor master, not the treasury

Owners usually respond to this by instructing finance to pay MSME vendors faster. That misses where the control actually breaks. Payment runs are driven by the vendor master, and in most businesses between Rs 100 crore and Rs 1,000 crore of turnover the vendor master does not reliably know which suppliers are micro or small.

• The Udyam registration number is captured in a free-text remarks field, or not at all, so no system rule can act on it.

• Vendors onboarded before FY 2023-24 were never asked for a declaration, and nobody went back to collect one.

• The MSME flag, where it exists, is set once at onboarding and never refreshed, even though classification depends on investment and turnover figures that change every year.

• Purchase orders carry 60- or 90-day credit terms that the statute overrides. The PO template was simply never revisited.

If the flag is unreliable, every number downstream of it is unreliable: the ageing report, the MSME Form 1 filed with the Registrar, the Section 22 disclosure in the accounts and the tax audit add-back.

Who is covered, and who is not

• Only micro and small enterprises. Medium enterprises sit outside both the delayed-payment provisions and the tax disallowance.

• Wholesale and retail traders registered on Udyam are excluded. The Ministry of MSME's office memorandum dated 1 September 2021 restricts their benefit to priority sector lending.

• Classification thresholds were raised with effect from 1 April 2025. A small enterprise now extends up to Rs 25 crore of investment and Rs 100 crore of turnover. Vendors who sat outside the net a year ago may sit inside it today.

The practical point for a promoter is that over-flagging costs as much as under-flagging. Paying every vendor within 45 days because nobody sorted out the master data is a real working capital cost taken on for no legal reason.

Four things to ask for this quarter

• An ageing of micro and small vendor balances beyond 45 days as at each month end, not only 31 March. If the only date anyone looks at is the year-end, the exposure is being managed rather than measured.

• An exception report of vendors with a blank, duplicate or invalid Udyam number, together with the value of purchases routed through them.

• A reconciliation between the MSME Form 1 filed with the Registrar, due 30 April and 31 October, the Section 22 disclosure in the accounts, and the tax audit add-back. These three should agree. They frequently do not.

• The list of open purchase orders carrying payment terms beyond 45 days for a micro or small vendor, with the buyer's name against each.

That last report is worth pressing on. A buyer who negotiates 90-day terms with a small vendor has not won a discount. He has created an interest liability and a tax disallowance that the vendor may never invoice but the auditor will certainly find.

The bottom line

• MSME vendor payments run on a statutory 45-day clock that overrides whatever your purchase order says.

• Missing it costs three ways: compound interest at three times the bank rate, loss of the deduction in the year the expense arose, and a disclosure that flows into your published accounts.

• The fix is master data discipline - an annual declaration from every vendor, a validated Udyam field, and a payment run that reads it - not faster ad hoc payments.

• Reconcile the ROC filing, the accounts disclosure and the tax audit position yourself, before someone else does it for you.

By CA Dhruv Seth, Seth & Associates, Chartered Accountants, Lucknow

This article is for general information and does not constitute audit, legal or tax advice. Regulations change; please verify the current position or speak to a qualified adviser before acting.