[By Shaurya Talwar]
The author is a student of Gujarat National Law University, Gandhinagar.
Introduction
The Finance Act of 2023 introduced a juggernaut for business entities dealing with Micro and Small Enterprises by insertion of clause (h) in the Section 43B of the Income Tax Act of 19611 which has now come in force from the Financial Year 2024-25. To understand the repercussions of the same let us go through the relevant provisions.
The Section 43(b), IT Act, 1961 provides for such deductions which are only allowed if there is an actual payment before the filing date, with certain exemptions. Section 43(B)(h), Income Tax Act, 1961 provides that if the assessee has any payment due to any Micro or a small enterprise beyond the time period mentioned under S.15, MSMED Act,2 it shall only be allowed to be deducted in the year in which the actual payment is made. To simplify, any deductions on account of any purchase will only be allowed to be deducted in the year in which it is actually paid and not accrued.
If the tax is not paid within the time limit mentioned under the Section 15 of the MSMED Act, 2006 such purchase is to be treated as your business income under Section 28, IT Act, 1963 and the assessee will have to incur higher tax liability on account of such additional income.
Time period under the MSME Act
The MSMED Act, 2006 defines Micro and small enterprises on the basis of turnover and investments in plants & machinery. It is categorised as follows:
a. Micro enterprises
Turnover: Does not exceed Rs.5 Crores.
Investment in Plants & Machinery: Does not exceed Rs.1 Crore
b. Small Enterprises
Turnover: Does not exceed Rs.50 Crores
Investment in Plants & Machinery: Does not exceed Rs. 10 Crores.
The Section 15 of the MSMED Act, 2006 provides for the time period under which the payment is to be made to Micro and Small Enterprises. There are two categories for the same, which are as follows:
- In case of a written agreement: The payment is to be made within the credit period as agreed under a written agreement, however such period cannot exceed 45 days.
- In case of no written agreement: The payment is to be made within a period of 15 days.
Intention of the Legislature
The clause was inserted as a socio-economic measure to make sure there is sufficient liquidity with the Micro and small enterprises who often faced stretched credit cycles ranging from 67 days to 195 days which ultimately stretched their liquidity and consequently affecting their solvency. The clause was inserted to promote timely payments to such enterprises and to increase efficiency of the credit cycles as delayed payments often have a domino effect across all incidental sectors and industries, therefore the Government takes it very seriously. Prior to the Amendment itself, under the Section 16, MSMED Act,4 upon non-payment of the amount to the Micro and small enterprises within the stipulated time period attracted a compound interest at three times the bank rate notified by RBI.
The Standing Committee on Finance (2021-22) in its 46th Report titled “Strengthening credit flows to MSME Sector” highlighted the issues faced by micro and small enterprises in receiving timely payments from its buyers. Many stakeholders highlighted that despite the Section 15 statutory period many buyers often imposed a business condition of payment not before 60 or more days and micro and small enterprises often had to agree to such credit cycles due to business compulsion. In order to guarantee that all businesses, regardless of size, can function with comparable financial flexibility and promote a more equitable and balanced economic environment, it is imperative that these legislative frameworks be reevaluated.
Further the interest payments on such delayed payments was also not received by MSMEs. Therefore, MSMEs requested for a more strict control mechanism to ensure timely payment.
Delayed payments lead to working capital crunch which forces the MSMEs to avail loan and credit lines from banks, incurring interest payments which ultimately also lead to increase in prices of goods and services which then further reduces liquidity in the market. This essentially is a vicious cycle. In view of such requests of MSMEs, the clause was inserted to ensure timely payments to MSMEs via the Finance Act, 2023.
(Un)Intended Consequences
a. Competitive Advantage of Medium Enterprises vis-a-vis Micro and Small Enterprises
Increased size and resources, medium-sized businesses can now provide more flexible payment options. On the other hand, these rules frequently place restrictions on micro and small businesses, making it impossible for them to offer more lenient terms for payments even though they are capable of doing so. This might make such buyers prefer medium enterprises which can offer a more liberal payment tenure in tune with the practical market credit cycles.
The Government has to realise the payment tenure just does not depend on the willingness of the buyer but on the market conditions and receipt of payment from further traders. Buyer of the first instance often have to first realise payment from further buyers to make the primary payment, however such payments again depend on market dynamics such as consumption and demand of such product, logistics-transportation efficiency as the goods might be moved from one part of the country to another via road or rail, seasonal changes and broad market conditions. It is no secret that private consumption has not quite picked up post Covid-19. Such forced regulatory changes will not change the market conditions rather further rattle the market players. In order to guarantee that all businesses, regardless of size, can function with comparable financial flexibility and promote a more equitable and balanced economic environment, it is imperative that these legislative frameworks be reevaluated.
b. Increased difficulties of Exporters
The Indian Exporter community have voiced their concerns with the Section 43B(h), IT Act, 1961. They have sought exemption from the clause as they often faced longer credit cycles compared to domestic consumptions. Indian Exporters receive payments for their transactions with an average credit cycle of 120 days compared to 14 days in case of domestic transactions.5 Further, RBI also allows a credit period of nine-months as export receipts take a longer period due to various risk factors such as geopolitical conditions, regulatory mechanism in the country of import and other difficulties in realisation of amount from the importer.
Exporters generally have to maintain a bigger inventory in lieu of additional uncertainties peculiar to the export industry. However, this is not a problem peculiar to Indian exporters, therefore countries such as China have relaxed regulations for their exports to ensure a smooth regulatory scenario for its exporters. This might affect the competitiveness of Indian exporters vis-a-vis Chinese and other Asian powerhouse exporters, ultimately damaging not only the export industry but also the MSME sector.
c. Arbitrariness of the 45 Day Period Payment Timeline.
On the face of it, the 45 payment period seems arbitrary, despite the fact that the average credit cycle for business transactions in India ranges much more than 45 days in India across most industries. There is no foundational logic behind the Section 15, MSMED Act which provides for a 15 to 45 days timeline for payment and is just a discretionary exercise of regulatory power. It is also an example of regulatory overreach in the Indian market forcing the hands of stakeholders to comply with strict guidelines despite the inability to do so.
Conclusion
It would be ignorant to say that delayed credit payments have a large scale negative impact on the health of an economy. The MSME sector has long been a victim of the business inefficiencies in India and it has now even become an expected part of Indian business culture. The Government therefore has realised the gravity of the situation and has come up with short hand measures to force a business culture change. However, Indian industries have not been known to positively accept regulatory changes. However, that alone should not be a reason to not bring a dynamic cultural change across business communities in India.
While the spirit of the Government is in the right direction, the regulatory efforts have to be put up in different avenues. The Government has to work on the reasons for the delayed payments cycles itself which would organically lead to faster realisation of payment. There are certain suggestions such as:
- The Government which is the biggest business player often itself is found majorly delaying its payments owed to companies, which has its effect across all industries. Therefore, the Government should take the lead in timely payments for its purchases.
- Decreasing the margins offered by the bank on the bills receivables. Currently the Banks discount any bill receivable at a 25-40% margin, which is again a big structural hindrance for MSMEs.
- Reduction in time period for granting loans to MSMEs, which often face considerable time delay before getting access to credit lines.
- Encouraging the adoption of platforms such as TReDS which allow digital and smooth invoice discounting by making people aware of such services.