By CA Surekha Ahuja
When a mandatory reporting clause requires figures
that have no bearing on any tax disallowance, it is not rigour — it is an
unnecessary burden on businesses and auditors alike. A hard look at the
mismatch between Clause 22(ii) and Section 43B(h).
There is a specific kind of compliance burden that is harder
to justify than a difficult one — and that is a purposeless one.
Clause 22(ii) of Form 3CD, as currently worded, falls squarely into this
category. It demands reporting of data that has no connection to the tax
disallowance it is meant to facilitate.
This post examines the structural mismatch between Clause
22(ii) and Section 43B(h), explains why the current reporting scope is wider
than any legitimate tax purpose, and suggests both interim practical steps for
practitioners and the case for reform.
What Clause 22(ii) Requires
Clause 22(ii) of Form 3CD requires the tax auditor to report
the total amount required to be paid to a Micro or Small Enterprise (as
referred to in Section 15 of the MSMED Act, 2006) during the previous
year — not merely the amount outstanding at year-end.
The Core Mismatch: Flow Data vs. Stock-Based Disallowance
Section 43B(h), inserted by the Finance Act 2023 with effect
from FY 2023–24, disallows any sum payable to a Micro or Small Enterprise as a
business deduction unless it is actually paid within the credit period
prescribed under Section 15 of the MSMED Act — 15 days (without written
agreement) or 45 days (with written agreement). The amount remaining unpaid
beyond these limits as at 31st March is added back. Amounts paid
during the year — whether in 10 days or 40 days — are tax-neutral. No
disallowance. No consequence.
This is, by design, a stock-based disallowance.
It operates on what remains unpaid at year-end. Clause 22(ii), however,
demands flow data — the total amount that moved through the
ledger over twelve months. These two are structurally incompatible.
|
Parameter |
Clause 22(ii) Requires |
Section 43B(h) Operates On |
|
Total invoiced by MSME vendors during the year |
Yes — mandatorily Tax Irrelevant |
Not needed |
|
Amounts
paid within 15/45 days during the year |
Yes —
part of computation Zero consequence |
Fully
deductible — no examination required |
|
Amount unpaid at 31st March beyond credit period |
Yes — included Relevant |
This is the only figure that drives
disallowance |
|
Interest
on delayed MSME payments (P&L) |
Implicit
verification expected |
Disallowed
regardless under Sec 23 of MSMED Act — no audit consequence |
"If a business has paid ₹11.4 crore to MSME vendors
during the year and ₹60 lakh remains unpaid at 31st March, only ₹60 lakh is
relevant to Section 43B(h). Clause 22(ii) requires reporting and verification
of the entire ₹12 crore — an exercise with zero incremental tax
consequence."
Three Questions That Need Answers
1 What is the administrative purpose of "total during the year"?
The aggregate payment figure has no corresponding entry in any vendor's ITR, making cross-verification impossible. It does not determine the disallowance quantum, which depends solely on the year-end unpaid balance. If the intent is MSME policy data collection, the mechanism for that is the Ministry of MSME — not a tax audit report. The clause's reporting scope is wider than any identifiable tax purpose.
2 Was Clause 22(ii) recalibrated when Section 43B(h) was inserted?
Section 43B(h) was inserted by the Finance Act 2023. Clause 22(ii) predates it and appears to have been carried forward without alignment to the new disallowance provision. The result is a reporting obligation drafted around an older framework being applied to a provision with a fundamentally different operative basis. This is not a policy disagreement — it is a drafting misalignment that has created a recurring compliance burden with no corresponding tax outcome.
3 Should the tax auditor verify MSME interest provisions?
Interest on delayed MSME payments under Section 16 of the
MSMED Act is non-deductible under Section 23 of that Act — regardless of how it
is treated in the books. Whether the auditor verifies that adequate interest
has been provided changes nothing in the tax computation. This is an audit step
without an audit consequence, which is a use of professional time that is
difficult to justify.
The Practical Burden
For a business with 150 or more vendors, complying with
Clause 22(ii) as currently worded requires: identifying all vendors holding
valid UDYAM registrations as Micro or Small enterprises (which most ERP systems
do not natively track); extracting twelve months of payment history for each
such vendor; date-stamping each transaction against invoice dates to verify
payment timelines; and presenting all of this to the tax auditor for
verification.
For large manufacturing or trading concerns, this is a
multi-week exercise each audit season — consuming finance team bandwidth, ERP
customisation effort, and significant audit hours. The cost is real and
recurring. The tax outcome it generates is nil, to the extent amounts were paid
during the year.
The Logical Fix
Restrict Clause 22(ii) reporting to: (a) amounts remaining
unpaid to MSME vendors at the close of the previous year, categorised by
whether they fall within or beyond the permissible credit period under Section
15 of the MSMED Act; and (b) the quantum added back under Section 43B(h). This
aligns reporting with the disallowance provision it is meant to facilitate —
and eliminates the rest as superfluous.
Interim Practical Approach for Tax Auditors
Until the clause is amended, the following approach can
bring structure to the exercise while managing the scope to what is
professionally defensible:
Recommended Protocol — AY 2025–26 Onwards
→Management representation as the primary basis. Obtain
a written representation from management listing all MSME-registered vendors
(with UDYAM numbers), total amounts invoiced during the year, amounts paid, and
amounts outstanding at year-end with dates. This defines your verification
perimeter and shifts the factual foundation to management.
→Vendor-tagged ledger data. Where the client's
accounting system permits MSME-tagging of the vendor master, a ledger extract
is the most efficient and defensible basis. Advocate for prospective tagging so
that future years are less burdensome.
→Risk-based sampling for the "total during
year" figure. Since this figure has no tax consequence, a
documented risk-based sampling approach — rather than exhaustive verification —
is professionally defensible, provided the methodology is clearly recorded in
the working papers.
→Scope limitation disclosure. Where MSME
classification data is unavailable — as will frequently be the case for vendors
who have not shared UDYAM details — state this limitation explicitly in the
audit file. The auditor's responsibility is bounded by information reasonably
available and formally requested.
→Formal ICAI representation. Raise this through
your regional branch to ICAI's Direct Taxes Committee for a representation to
CBDT. The ask is narrow, technically grounded, and non-controversial: align
Clause 22(ii) reporting with the operative scope of Section 43B(h).
The rationalisation of Clause 22(ii) is precisely the kind of targeted, technical reform that such representations are designed to achieve. The ask does not dilute MSME protection in any way — Section 43B(h) should remain exactly as it is. The ask is simply to align the reporting obligation with the tax consequence. That is a request that is difficult to argue against on either policy or administrative grounds.
In Summary
Clause 22(ii) as currently worded requires reporting of the
total amount paid to MSME vendors during the entire previous year. Section
43B(h) disallows only what remains unpaid at year-end. The former is a flow
measure; the latter is a stock-based disallowance. Aligning the two is not a
radical ask — it is basic legislative housekeeping that would save the business
community and the auditing profession significant effort every audit season, at
no cost to revenue and no dilution of MSME protection.
