MSME Tax Audit in India: Final Form 3CD Season and What to Get Right Before Form 26 Arrives

India’s tax audit framework for micro, small and medium enterprises (MSMEs) is undergoing a considerable transition. For income earned during FY 2025-26, businesses subject to tax audit remain governed by the Income Tax Act 1961 and must comply with the existing Forms 3CA/3CB and 3CD framework.

The FY 2025-26 tax audit is particularly important for MSMEs because Form 3CD has enhanced reporting requirements for payments to micro and small enterprises. These disclosures require businesses to examine their supplier classification, payment timelines, outstanding dues, and potential tax disallowances under Section 43B(h).

From FY 2026-27, tax audits move to the new Form 26 under the Income Tax Act 2025. Form 26 consolidates the earlier Forms 3CA, 3CB, and 3CD into a single tax audit report.

MSME tax audit requirements for FY 2025-26

For FY 2025-26, the tax audit requirement continues under Section 44AB of the Income Tax Act 1961. The Income Tax Department confirms that the existing Forms 3CA, 3CB, and 3CD continue to apply for this year.

For businesses, the general tax audit threshold is turnover or gross receipts exceeding INR 10 million, with the threshold increasing to INR 100 million where cash receipts and cash payments do not exceed the prescribed 5 per cent limits.

An MSME that crosses the applicable threshold must therefore prepare its accounts and supporting records for tax audit using the existing Form 3CD reporting framework.

Enhanced MSME disclosures under Clause 22

One of the most important changes for FY 2025-26 is the expanded reporting requirement under Clause 22 of Form 3CD.

Following the amendments to Form 3CD applicable from 1 April 2025, Clause 22 requires the tax auditor to report more detailed information concerning amounts payable to micro and small enterprises under Section 15 of the Micro, Small and Medium Enterprises Development Act 2006 (MSMED Act).

The revised Clause 22 requires reporting of:

1. Interest inadmissible under Section 23 of the MSMED Act
2. The total amount required to be paid to micro or small enterprises under Section 15 during the previous year
3. Of that amount:
   • The amount paid within the time prescribed under Section 15
   • The amount not paid within the prescribed time and therefore inadmissible for the previous year.

This substantially expands the information that businesses need to maintain for tax audit purposes.

Why Section 15 of the MSMED Act matters

Section 15 of the MSMED Act establishes the payment timeline for amounts owed to qualifying micro and small enterprises.

Where a written agreement exists, the agreed payment period cannot exceed 45 days from the date of acceptance or deemed acceptance of the goods or services. Where there is no written agreement, the payment must generally be made within 15 days of acceptance or deemed acceptance.

Therefore, an MSME buyer cannot determine its Clause 22 reporting solely by looking at whether an invoice remained unpaid at year-end. It needs to establish the relevant acceptance or deemed acceptance date, applicable payment period, and actual payment date.

This makes supplier-level payment and classification records particularly important for the FY 2025-26 tax audit.

Section 43B(h) and delayed payments to MSMEs

The enhanced Clause 22 disclosures are closely connected with Section 43B(h) of the Income Tax Act 1961.

Section 43B(h) applies to sums payable to a micro or small enterprise that remain unpaid beyond the payment period specified under Section 15 of the MSMED Act. Such an amount is not deductible in the relevant previous year and is instead allowed as a deduction in the year in which the payment is actually made. Unlike the other provisions of Section 43B, payment before the due date for filing the income tax return does not generally cure a Section 43B(h) delay.

For example, if an MSME buyer has an amount payable to a qualifying micro or small enterprise and the Section 15 payment period has expired by 31 March 2026, the business needs to assess the resulting Section 43B(h) disallowance for FY 2025-26.

The business should therefore maintain evidence showing:

1. whether the supplier is classified as a micro or small enterprise
2. Supplier’s relevant MSME/Udyam details
3. Date of acceptance or deemed acceptance
4. Contractual payment terms, where applicable
5. Statutory payment deadline under Section 15
6. Amount outstanding
7. Actual payment date
8. Amount potentially disallowable under Section 43B(h).

Clause 26 and Section 43B reporting

Clause 26 of Form 3CD deals more broadly with amounts covered by Section 43B. It is therefore important not to describe Clause 26 as an exclusively MSME-related provision.

The amended Form 3CD framework separately identifies sums payable to micro or small enterprises beyond the Section 15 period, while Clause 26 continues to capture the broader Section 43B reporting requirements. The Income Tax Department’s FY 2025-26 validation rules specifically map a sum payable to a micro or small enterprise beyond the Section 15 period to Clause 22(iii)(b), alongside the Section 43B reporting framework.

Accordingly, for FY 2025-26, MSMEs should review Clause 22 and Clause 26 together but should not treat them as interchangeable.

Form 3CD provision	MSME relevance
Clause 22	Specific reporting of amounts payable to micro and small enterprises, payments within or beyond the Section 15 period, and inadmissible interest under Section 23 of the MSMED Act
Clause 26	Broader reporting of amounts covered by Section 43B, including the applicable tax treatment of qualifying liabilities
Section 43B(h)	Restricts the deduction for qualifying amounts payable to micro and small enterprises where payment is made beyond the Section 15 period

Source: Income Tax Department, Government of India

What MSMEs should do for the FY 2025-26 tax audit

MSMEs subject to tax audit should not rely solely on their year-end accounts to prepare these disclosures.

Businesses should reconcile their vendor master, purchase records, Udyam/MSME classification information, creditor ageing, invoices, acceptance dates, contractual payment terms, bank payments, and outstanding balances.

They should also identify amounts that:

• Were payable to micro or small enterprises
• Were paid within the applicable Section 15 period
• Were paid after the Section 15 period
• Remained unpaid at the end of FY 2025-26
• May give rise to disallowance under Section 43B(h)

This documentation will support the auditor’s reporting under the revised Form 3CD framework.

Transition from Form 3CD to Form 26 from FY 2026-27

The tax audit framework changes for income earned from FY 2026-27.

The Income Tax Act 2025 applies to Tax Year 2026-27, and Form 26 becomes the prescribed tax audit report. The Income Tax Department states that Form 26 consolidates the erstwhile Forms 3CA, 3CB, and 3CD into a single unified form.

Transition from Form 3CD to Form 26
Income period	Applicable law	Tax audit form	MSME reporting approach
FY 2025-26	Income Tax Act 1961	Forms 3CA/3CB + 3CD	Enhanced Clause 22 and applicable Section 43B/Clause 26 reporting
FY 2026-27	Income Tax Act 2025	Form 26	Reporting under the new Form 26 framework
FY 2027-28 onward	Income Tax Act 2025	Form 26	New Act and Form 26 requirements

The transition is based on the period in which the income is earned, rather than simply the date on which the tax audit report is filed.

Consequently, an MSME’s tax audit relating to FY 2025-26 remains subject to Forms 3CA/3CB and 3CD, including the enhanced MSME disclosures under Clause 22. For income earned from FY 2026-27, the corresponding tax audit reporting moves to Form 26.

CLICK HERE: Who Needs to File Form 26 in India? Tax Audit Rules, Thresholds and New Reporting Areas

What changes for India’s MSMEs under Form 26?

Form 26 is not simply a renumbered Form 3CD. It consolidates and restructures the previous tax audit reporting framework into a single form with standardised reporting and separate schedules.

The Income Tax Department identifies several changes, including the consolidation of Forms 3CA, 3CB, and 3CD, rationalisation of audit disclosures, alignment with the ITR framework, consolidated reporting of disallowable expenditure, and separate schedules for areas such as losses, depreciation, deductions, prior-period items, receipts/income, and expenses.

For MSMEs, this means that the FY 2025-26 Clause 22/Clause 26 approach should not simply be carried forward as a set of Form 3CD clause numbers. Businesses should instead identify the corresponding MSME and statutory-payment reporting requirements in Form 26 and update their tax audit working papers accordingly.

Key takeaway for MSMEs

FY 2025-26 is the final tax audit cycle under the Income Tax Act 1961 and Form 3CD. For MSMEs, this cycle carries enhanced disclosure requirements, particularly under Clause 22 for payments to micro and small enterprises and the related Section 43B(h) implications, alongside the broader Section 43B reporting under Clause 26.

From FY 2026-27, tax audits move to Form 26 under the Income Tax Act 2025. MSMEs should therefore complete their FY 2025-26 Clause 22 and Clause 26 reconciliations while simultaneously adapting their accounting, vendor, payment, and tax audit records to the new Form 26 reporting framework.