By CA Surekha Ahuja
Vendor Documentation and FY 2025–26 Year-End Compliance: Section 43B(h), MSMED Act, and Supporting Income Tax Provisions
Part 1 of this series covered the five documents required from vendors and the Form 3CD clause map. This post covers the complete Income Tax Act framework that mandates vendor documentation — including Section 43B(h) (the MSME payment rule operative from FY 2023–24), the parallel compound interest liability under the MSMED Act, and four supporting provisions under the Income Tax Act, 1961 — Sections 145, 40A(3), 269SS/269T, and 40(a)(ia) — each of which is directly engaged by your vendor ledger data for FY 2025–26.
Section 43B(h) — MSME Payment Disallowance
Section 43B(h) was inserted in the Income Tax Act, 1961 with effect from FY 2023–24 (Assessment Year 2024–25). It is fully operative for AY 2026–27 (FY 2025–26). The provision stipulates that any sum payable to a Micro or Small Enterprise is deductible as a business expense only if actually paid within the credit period prescribed under the MSMED Act, 2006. If the amount remains outstanding as at 31 March 2026 beyond the permitted credit period, the deduction is denied in the year of accrual — irrespective of when it is eventually paid.
Credit Periods under MSMED Act:
| Situation | Maximum Credit Period |
|---|---|
| No written agreement between buyer and MSME vendor | 15 days from date of delivery/acceptance |
| Written agreement between buyer and MSME vendor | 45 days (maximum permissible; cannot be extended by contract) |
Tax Impact — Section 43B(h):
| Scenario | Tax Treatment |
|---|---|
| Payment made within the credit period | Full deduction allowed in FY 2025–26. No disallowance. No adverse disclosure in Form 3CD Clause 26(B) |
| Payment outstanding beyond the credit period as at 31/03/2026 | Deduction disallowed in FY 2025–26 (AY 2026–27). Allowed only in the year of actual payment |
Applies to: Micro and Small Enterprises — not Medium Enterprises. The Udyam Registration Certificate is the only basis for this classification.
Form 3CD Clause 26(B): The tax auditor must disclose, vendor-wise, all amounts payable to Micro and Small Enterprises, the credit period applicable, amounts paid within time, and amounts outstanding beyond the credit period. This clause cannot be completed without MSME Declarations and Udyam Certificates for each such vendor.
Compound Interest Liability — Section 16, MSMED Act, 2006
This provision operates independently of Section 43B(h) and is frequently overlooked.
| Particulars | Details |
|---|---|
| Provision | Section 16, MSMED Act, 2006 |
| Trigger | Any delayed payment to a Micro or Small Enterprise beyond the agreed or statutory credit period |
| Rate of Interest | Compound interest at three times the RBI bank rate, with monthly rests |
| When it Applies | From the day after the due date of payment — automatically, without any demand from the vendor |
| Applies to | Micro and Small Enterprises only |
| Relation to Section 43B(h) | Both apply independently. The income tax disallowance does not discharge the compound interest liability |
This liability does not require a demand notice, court order, or any action by the vendor. It accrues as a matter of law and may be raised in proceedings before the MSME Facilitation Council (MSEFC) at any time.
Section 145 — Method of Accounting
Under Section 145 of the Income Tax Act, 1961, income chargeable under the head "Profits and Gains of Business or Profession" must be computed in accordance with either the mercantile basis or cash basis of accounting, applied consistently. The tax auditor confirms this under Form 3CD Clause 1.
The auditor's certification of the method of accounting depends on the verifiability of the balances in the books. Confirmed vendor statements — establishing that accruals recorded in the books correspond to amounts the vendor also records as receivable — are the external evidence of this verifiability. Without vendor confirmations, the creditor balances in the books are supported only by internal records, which is an insufficient audit position.
Section 40A(3) — Cash Payment Disallowance
| Particulars | Details |
|---|---|
| Provision | Section 40A(3), Income Tax Act, 1961 |
| Trigger | Cash payment exceeding ₹10,000 to a single vendor in a single day |
| Disallowance | 100% of the payment — no proportionate relief |
| Form 3CD Clause | Clause 21(d) — Auditor must report all such payments |
| Vendor Document | Statement of Accounts (Document 1) — used to cross-verify all cash transactions in the vendor ledger |
There is no threshold below which cash payments are acceptable once they exceed ₹10,000 to a single person in a day. The disallowance is absolute. Vendor account statements, when reconciled against the books, bring cash payments into view as a distinct category for the tax auditor's examination.
Sections 269SS and 269T — Prohibition on Cash Loans and Deposits
| Particulars | Details |
|---|---|
| Section 269SS | Prohibits acceptance of any loan, deposit, or advance of ₹20,000 or more in cash in a single transaction |
| Section 269T | Prohibits repayment of any such loan, deposit, or advance in cash |
| Penalty | Sections 271D and 271E — Penalty equal to the full amount of the impugned transaction |
| Form 3CD Clause | Clause 31 — Tax auditor must specifically identify and report contraventions |
| Vendor Document | Statement of Accounts (Document 1) — ledger cross-check to surface such transactions |
Contraventions of Sections 269SS and 269T must be disclosed in Form 3CD Clause 31 by the tax auditor. Vendor confirmations and account statements allow both the business and the auditor to identify such transactions before the return is filed — when they can still be addressed — rather than in an assessment proceeding.
Section 40(a)(ia) — TDS Disallowance
| Particulars | Details |
|---|---|
| Provision | Section 40(a)(ia), Income Tax Act, 1961 |
| Trigger | TDS required but not deducted, or deducted at a rate lower than applicable, on vendor payments |
| Applicable Sections | Section 194C (contractors), 194J (professionals/technical services), 194I (rent), 194H (commission), 194Q (purchase of goods above threshold) |
| Disallowance | 30% of the underlying payment — not merely the TDS amount |
| Form 3CD Clause | Clause 34(b) — Auditor must verify and report TDS deducted, deposited, and Form 16A issued |
| Vendor Document | Form 16A (Document 5) + 26AS/AIS reconciliation |
Illustration: Professional fee paid to a vendor: ₹10,00,000. TDS @ 10% required but not deducted: ₹1,00,000. Disallowance u/s 40(a)(ia): ₹3,00,000 (30% of ₹10,00,000) — not merely ₹1,00,000. Reconciliation of the vendor's Form 16A against 26AS and the TDS register is the mechanism for identifying such gaps before the audit.
Consolidated Provision Reference Table — FY 2025–26 (AY 2026–27)
| Provision | Subject | Consequence | Vendor Document |
|---|---|---|---|
| Section 43B(h) | MSME payment beyond credit period | Disallowance of outstanding amount in year of accrual | MSME Declaration + Udyam Certificate |
| Section 16, MSMED Act | Delayed payment to Micro/Small Enterprise | Compound interest at 3× RBI bank rate, monthly rests | MSME Declaration + Udyam Certificate |
| Section 145 | Method of accounting — verifiability | Adverse audit remark; unverifiable balances | Statement of Accounts + Balance Confirmation |
| Section 40A(3) | Cash payment above ₹10,000 to single vendor | 100% disallowance of the payment | Statement of Accounts |
| Section 269SS/269T | Cash loan/deposit/repayment above ₹20,000 | Penalty equal to full transaction amount — Sections 271D/271E | Statement of Accounts |
| Section 40(a)(ia) | TDS not deducted or short-deducted | 30% disallowance of underlying expenditure | Form 16A + 26AS/AIS reconciliation |
Compliance Tip
- Send the vendor request letter for all five documents on or before 15 June 2026.
- Maintain a separate MSME Vendor Register recording each vendor's Udyam status, credit period applicable, invoice dates, payment dates, and any overdue amounts as at 31/03/2026.
- Vendors who do not respond by 30 June 2026 may be treated as Non-MSME — but only if the request was formally made in writing and documented.
- Reconcile 26AS and AIS with your TDS payable ledger and every Form 16A received before submitting data to the tax auditor.
- The Tax Audit Report (Form 3CD) is due by 30 September 2026.
Closing Insight
Each of the six provisions covered in this post — Section 43B(h), Section 16 of the MSMED Act, Section 145, Section 40A(3), Sections 269SS/269T, and Section 40(a)(ia) — operates independently. A business may be exposed to more than one of them simultaneously for the same vendor transaction. The five-document vendor request covers all of them. Collecting these documents is not a year-end administrative task — it is the evidence base on which your tax audit rests.
