Corporates, amended I-T law squeezing MSMEs

The amended I-T Act penalises companies that do not pay MSME vendors within 45 days, but has several unintended consequences

The Prime Minister on Tuesday tweeted a message announcing the government’s latest efforts to strengthen the Micro, Small and Medium Enterprises (MSMEs) by revamping the Credit Guarantee Scheme to increase the flow of credit to this sector. The biggest problem that the small entrepreneur faces is the non-availability of timely and adequate credit at reasonable interest rates. And a major cause of this is the low availability of bank finance on account of the high-risk perception of lending to this sector. Every effort must be made to strengthen this sector as the importance of small and medium enterprises for the economy cannot be overemphasised; they contribute to roughly half the output, employment and even exports in the industrial sector.

There are approximately 64 million such enterprises, not just in industry and manufacturing, but in services including single person services such as cobblers, paan shops or hair cutting salons. In manufacturing alone there are an estimated 1.2 million units. There is also an MSME ministry at the Centre which was established in 2007. One year before that, the Parliament passed the MSME Act to promote and develop the MSMEs and also enhance their competitiveness. They have been given special preference when it comes to procurement of goods and services by central, state and local governments. There are special provisions to ensure that they get formal credit from banks and non-banks. The loans to MSMEs are counted toward the bank’s obligation to fulfil priority sector lending.

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In 2020, the government recognised that the definition of an MSME needs to be changed and updated. So now the definition is in terms of investment or turnover. For micro units it is up to Rs 1 crore investment or a Rs 5-crore turnover, for small enterprises it is Rs 10-crore investment or Rs 50 crore turnover, and for medium units, it is up to Rs 50 crore and Rs 250 crore respectively.

Over the years there have been several policy initiatives by the Centre and also various states to provide a fillip to the businesses in the MSME sector. The problems and challenges plaguing the MSMEs are a lack of adequate credit, marketing and technology, lack of financial literacy, over dependence on a single or a few customers, or getting the right talent. Giving support to MSME’s and ensuring that they survive and thrive is in the spirit of inclusive growth.

One of the most pressing issues that the MSME’s face collectively is that of delayed payments. Since they face a large customer, with great clout, they have limited bargaining powers. Often the last part of the payment of the present order, is clubbed with the next repeat order. So it is possible that the customer always holds back 10-20% of the payment that is due. This is like a portion of the working capital of the MSMEs that is permanently locked and lying with the customer. Most have only one large buyer. So they cannot afford to name and shame that customer. Nor can they drag that customer to court or to the Insolvency and Bankruptcy process for want of a payment delayed beyond six months. Because if the small vendor does that to his big client, then that vendor will get permanently black listed and lose all business. Incidentally this applies to large companies both from the public or private sector.

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The railways for example probably have a million small vendors, and for each of them they have only one customer. Even though the 2006 Act explicitly prohibits any delay beyond 45 days, this Act is observed more in the breach. A Dun and Bradstreet report says that estimated delayed payments across all MSMEs is about Rs 10 lakh crores. The annual interest cost alone on this staggering amount is Rs 1 lakh crore. If the delayed payments are cleared as per the provision of the 2006 Act it would be like releasing a subsidy of Rs 1 lakh crore to the MSMEs.

In the recently passed Union Budget there is an amendment to the Income Tax Act Section 43B. In short, the amendment says that if a company does not pay their MSME vendor within 45 days, then that expense will not be allowed as tax deductible, and will be counted as income to be taxed. The amendment is well intended. But the effect of this will regrettably be perverse.

Firstly, some large companies will simply drop MSME purchases, fearing penal action from income tax authorities. Since non-MSME purchases do not attract this penalty, that is a safe route.

A second more serious problem with amendment to 43B is that it needs an auditor to certify by March 31 of the financial year. So if a buyer delays payment until the last day, say till March 30, and then pays off, no penalty will apply. So this is a loophole. Or else if there is delayed payment and the prospect of not getting tax deduction this year, the large buyer will simply postpone payment to the next year and claim a full tax deduction next year. This nullifies any penalty effect. Even the Institute of Chartered Accountants of India’s journal has pointed out this unintended consequence of the amendment.

However, an effective measure would be to cut off the oxygen of GST filing to the large buyer. Since every purchase is logged into the GST network, and an MSME is identified by the Udyam registration number, the large buyer should not be allowed to file its GST returns for the next month (or beyond the 45-day cycle) unless it has cleared all MSME payments. This confirmation that the MSME payment has been made is done by the large buyer posting the transaction on the Trade Receivables portal of the RBI.

All this being systems driven removes delays. It also will not put the MSMEs in mortal fear of displeasing their maai baap client and customer. This would go a long way in improving the ease of doing business for the MSMEs. The government must push this reform even though large corporations will resist it, for this step forces them to clear their dues within 45 days.

Meanwhile, though the latest government effort to strengthen the MSME is heartening. Much more is needed to help this all-important sector of the Indian economy.

(The writer is a noted economist) (Syndicate: The Billion Press)