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What Is the Risk of Delayed Payment to MSME Suppliers?

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of the economy, contributing significantly to employment and industrial output. However, one of the biggest challenges they face is delayed payments from large buyers, which creates financial distress and affects their sustainability. While buyers may assume that deferring payments benefits their cash flow, they often overlook the risks associated with such delays—especially legal and tax-related consequences under the Income Tax Act, 1961, and the MSME Development Act, 2006.

Let’s understand in detail!

Risks Buyers Face When MSME Suppliers Receive Late Payments

1. Supply Chain Disruptions

MSMEs operate on limited working capital, and any delay in receiving payments can halt production, causing supply chain disruptions. For buyers, this results in stock shortages, project delays, and potential revenue loss. Large companies relying on MSME suppliers for critical inputs or services may find themselves in a bottleneck situation, affecting their ability to meet customer demands.

2. Income Tax Disallowance of Expenses Under Section 43B(h)

A crucial financial risk buyers face when delaying payments to MSME suppliers is the potential disallowance of expenses under the Income Tax Act, of 1961.

As per the Finance Act, 2023, a new clause Section 43B(h) was introduced, stating that any payments due to MSMEs, if not made within the prescribed time limit under the MSME Development Act, 2006 (i.e., within 45 days if there is a written agreement, or 15 days otherwise), will not be allowed as a deduction under income tax in that financial year.
This means that buyers who delay payments beyond the specified period will not be able to claim the expense as a deduction, leading to an increased taxable income and higher tax liability.

Example:

If a company purchases raw materials worth ₹50 lakh from an MSME supplier and fails to clear the dues within the stipulated period, the amount will be added back to the taxable income, leading to additional tax outflows.

3. Legal and Compliance Risks Under the MSME Act, 2006

The MSME Development Act, 2006, mandates that payments to MSME suppliers be made within:

15 days if there is no written agreement.
45 days if there is a written contract.

Failure to comply attracts penal interest at three times the RBI's notified bank rate. This additional financial burden can be significant and may lead to legal disputes, tarnishing the buyer's reputation and business relationships.

4. Increased Costs Due to Supplier Instability

When MSMEs face cash flow issues due to delayed payments, they may increase their prices to compensate for financing costs, pass on the burden through higher interest charges, or struggle to fulfil orders. Buyers may then be forced to source from alternative suppliers at higher prices, increasing procurement costs.

5. Quality Compromise and Reputational Risks

Cash-strapped MSMEs might resort to using lower-quality materials or cutting corners in production, leading to defective products, higher rejection rates, and potential legal liabilities for buyers. This can damage brand reputation and customer trust, leading to long-term business losses.

6. Weakening of Buyer-Supplier Relationships

Delaying payments creates distrust between buyers and MSME suppliers. Suppliers may refuse to prioritize orders, withdraw from contracts, or shift to competitors who offer timely payments. Losing reliable suppliers can create long-term procurement challenges.

How Buyers Can Avoid These Risks

Ensure Timely Payments: Adhering to payment timelines helps maintain compliance and good relationships with MSMEs.
Monitor Payment Cycles: Implement automated payment tracking systems to avoid delays.
Negotiate Fair Payment Terms: Establish realistic credit periods that align with both parties' financial needs.
Use Supply Chain Financing: Explore options like invoice discounting and early payment programs to support MSME liquidity.

Conclusion

Late payments to MSME suppliers are not just a financial burden for small businesses—they also pose serious risks for buyers, including supply chain disruptions, increased tax liabilities, legal penalties, and reputational damage. With the introduction of Section 43B(h) of the Income Tax Act, the consequences of delayed payments have become even more significant. To ensure smooth operations and financial efficiency, buyers must prioritize timely payments, comply with tax provisions, and foster strong supplier relationships.

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