If your business buys from Micro or Small suppliers and doesn’t pay them within the statutory window, two separate consequences follow, and they are not the same consequence wearing two names. One is a payment obligation to your vendor under the MSMED Act, 2006. The other is an income tax disallowance under Section 43B(h) of the Income Tax Act, 1961, introduced by the Finance Act 2023 and effective from AY 2024-25. They’re triggered by the same delay, computed differently, land on different people, and behave differently at year-end.
We built a free MSME Interest & Disallowance Calculator to work out both numbers, vendor by vendor and invoice by invoice, because getting this wrong in either direction (understating a real liability, or overstating a disallowance that doesn’t actually apply) is easy to do by hand. This post covers the specific points that tend to get missed even when someone is trying to get it right.
First, who this actually applies to
Both provisions apply only where the supplier is a registered Micro or Small enterprise engaged in manufacturing or services. Two exclusions catch people out:
- Medium Enterprises fall outside the definition of “supplier” for Section 16 of the MSMED Act, so neither the interest nor the Section 43B(h) disallowance apply, regardless of how overdue the payment is.
- Traders were never “enterprises” under Section 2 of the MSMED Act at all, which covers only manufacturing and services. Udyam registration for traders, introduced in 2021, extends Priority Sector Lending eligibility only. It does not bring traders within Sections 15 and 16. A Udyam-registered trader vendor still doesn’t trigger either provision.
Get the category wrong and every number that follows is wrong with it.
Where the interest actually comes from, and how a vendor takes it
The interest itself isn’t optional or negotiable away by contract. Under Section 15 of the MSMED Act, payment is due within 15 days of acceptance if there’s no written agreement, or by whatever period the buyer and supplier agreed in writing, capped at 45 days regardless of what the agreement says. Miss that date, and Section 16 imposes compound interest with monthly rests, at three times the RBI Bank Rate, running from the day after the due date until actual payment. This accrues by operation of law. Nobody needs to invoice it for it to exist.
Where it gets missed is in the gap between the interest existing and the vendor collecting it. It doesn’t show up automatically in your books or theirs. A supplier who wants to actually recover it has a few routes:
- Raise it directly with the buyer, ideally with the calculation attached rather than a demand for “interest as applicable.” A number the buyer can check tends to get paid faster than one they have to derive themselves.
- File with the Micro and Small Enterprises Facilitation Council (MSEFC) via the MSME Samadhaan portal, which exists specifically for delayed-payment disputes and can proceed to conciliation and, if that fails, arbitration under the Act’s own dispute mechanism.
- Civil recovery, in the background, if it comes to that. Section 18(5) requires any reference before the Council to be decided within 90 days of the date it’s taken up.
Before any of that, work out the actual number. Compound interest with monthly rests at three times a moving RBI rate isn’t something to eyeball, and a demand with a wrong or overstated figure gives the other side an easy way to stall. That’s the practical reason we built the calculator: enter the invoice dates, terms and payment history, and it walks each invoice forward through every rate change and partial payment to the actual figure, referencing the historical RBI Bank Rate rather than today’s rate applied retroactively across the whole period.
From the buyer’s side, the corresponding discipline is provisioning it, not waiting for a demand. If overdue MSME balances are sitting on your books unprovisioned, both your financials and your tax position are already behind where they should be.
GST: net or gross, and a nuance in the other direction too
Two separate GST questions show up here, and they don’t have the same answer.
Is the interest computed on the GST-inclusive invoice value, or only on the base amount? Section 16 refers to “the amount due,” which is what the buyer contractually owes the supplier, and that’s the full invoice value, GST included. There’s no carve-out in the Act for the tax component. Our calculator computes interest on base plus GST for exactly this reason. If you’ve seen a calculation run only on the base value, it understates the actual exposure.
Is GST payable on the interest itself, once it’s finally received? This is the one that surprises people, including suppliers who’ve been chasing the principal for months and haven’t thought about the interest as a separate taxable event. Under Section 15(2)(d) of the CGST Act, interest, late fee or penalty for delayed payment of consideration is includible in the value of supply. Statutory MSMED interest isn’t excluded from that. When a supplier finally recovers Section 16 interest, it’s taxable output on their end, not a clean, tax-free recovery of what they were owed.
Two disallowances, not one: interest under Section 23 vs the outstanding amount under Section 43B(h)
This is the part most likely to get collapsed into a single line item when it isn’t one.
Section 23 of the MSMED Act says that any interest paid or payable under the Act is never allowed as a deduction when computing income under the Income Tax Act. Full stop, no year-end test, no reversal later. If a buyer books Section 16 interest as a finance cost in its accounts and then claims it as a deduction, that deduction has to be added back. This is treated as penal in nature, not a normal cost of doing business, which is exactly why the Act ring-fences it from Section 37 deductibility.
Section 43B(h) of the Income Tax Act is a completely different mechanism, aimed at the principal, not the interest. It disallows the deduction for the underlying expense (what you owe the vendor for the goods or services themselves) if it’s still unpaid beyond the Section 15 time limit as of the financial year-end. Two things follow from that framing that people frequently miss:
- It’s tested at FY-end, not on every individual invoice as it goes overdue. An invoice that ran 60 days late but was paid in full before March 31 creates no Section 43B(h) disallowance at all, even though it clearly breached the 45-day cap and Section 16 interest still accrued on it for those 60 days. The interest question and the disallowance question are answered independently.
- It’s a timing disallowance, not a permanent one. The amount added back in the year it was outstanding becomes deductible again in whichever year it’s actually paid, even if that’s years later. Section 23 interest never gets that second chance. This is the single clearest way to tell the two apart: if it can be reclaimed later on payment, it’s the 43B(h) principal disallowance; if it can’t, it’s the Section 23 interest.
There’s a further wrinkle on how much of an outstanding invoice is disallowed under Section 43B(h), and it depends on whether you’ve claimed input tax credit on the GST component:
- If ITC hasn’t been claimed, the full outstanding amount, base plus GST, is disallowed.
- If ITC has been claimed, only the base-value share of what’s still outstanding is disallowed. The logic is that the GST portion isn’t really “your” expense once you’ve claimed the credit against it, so only the underlying purchase cost is at risk.
The tax audit angle: this doesn’t stay hidden
Even if a business doesn’t self-report an overdue MSME balance correctly in its return, the tax auditor is separately required to flag it. Form 3CD’s reporting on MSME dues covers both the Section 43B(h) principal amounts outstanding beyond the statutory time limit and the interest inadmissible under Section 23, vendor-wise, as of the balance sheet date. A tax auditor working from your books, not your assumptions, will surface this regardless of how it was treated in the computation of income. Getting the two disallowances right before the audit, rather than reconciling them against what the auditor reports, is the difference between a clean review and a scramble in September.
Where to actually start
If you have overdue balances to Micro or Small vendors sitting on your books right now, working out the real exposure, both the interest you (or they) may need to account for and the amount at risk of disallowance, is worth doing before it’s forced on you by a demand letter or an audit finding. The calculator handles the compounding, the rate history and the ITC-dependent disallowance split automatically, vendor by vendor, and gives you one combined number to work from.
If the numbers turn out larger than expected, or you’re not sure how a specific vendor category or payment history should be treated, get in touch. This is exactly the kind of thing worth getting right before it shows up in a tax audit report rather than after.