Anushruti Singh
Delayed payments; that’s what MSME businesses fear most.
Just digest this— Rs 10.7 lakh crores, i.e. 5.9 per cent of the gross value added (GVA) of Indian businesses is stuck annually as delayed payments from buyers to MSME suppliers, according to a 2023 report by the Global Alliance of Mass Entrepreneurship.
In fact, according to FCIB’s Credit and Collections Survey, customers in India paid on average 25 days after the due date in July, up from 16.5 days in February. Nearly half (44 per cent) of credit professionals report an increase in payment delays, with central bank issues being the most common cause. In February, the most common causes of payment delays were supply chain and delivery concerns.
The problem is further exacerbated by lack of credit.
“Delayed payments pose a significant challenge for MSMEs, impacting their operations and growth. Prolonged payment cycles strain working capital, constrain cash flow, and limit their ability to invest in expansion or innovation,” says Roshan Shah, Co-Founder & CEO at Volofin, a trade finance platform.
To resolve this issue, the government has brought in the 45-day payment rule.
“The significant issue of delayed payments to MSMEs, which affects their operations and growth, is acknowledged by the Finance Act 2023,” Karan Desai, Founder, Interface Ventures informs us.
“By making timely payments a tax-related condition, the act aims to improve the predictability of cash flows for MSMEs, thereby enhancing their operational and financial stability,” he adds.
Section 43B(h) explained
This directive, marked by the insertion of clause (h) in section 43B of the Income Tax Act, 1961, heralds a new era in enforcing payment regulations for small businesses. Let’s delve into the intricacies of this directive, its implications, and the reactions it has stirred within the business community.
To summarise, it mandates that any sum payable by an assessee to a micro or small enterprise beyond the stipulated time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act), shall only be allowed as a deduction when paid. This provision, while seemingly administrative, holds significant implications for both MSMEs and larger enterprises.
To understand it, one must grasp the definitions outlined in the MSMED Act, 2006, which classifies MSMEs based on their investments in plant, machinery, equipment, and turnover. Additionally, understanding the payment periods as outlined in section 15 of the MSMED Act is paramount. The adherence to these timelines not only ensures compliance but also fosters a conducive ecosystem for MSMEs to thrive.
Voices of the vanguard
While there are diverse opinions on whether it’s a good rule, Desai and Shah’s perspectives shed light on the practical implications and potential hurdles in ensuring compliance with the 45-day payment rule.
Desai feels that the role of tax penalties as a deterrent to late payments is crucial.
“The act’s approach, tying financial penalties to delayed payments, is intended to motivate companies to prioritise timely payments. It could also address the liquidity challenges faced by MSMEs. The concerns over potential unintended consequences highlight the importance of careful monitoring and possible adjustments to the policy to avoid negatively impacting the business ecosystem,” he says.
Shah calls it a positive move and asserts that the rule will promote fair business practices and aid small enterprises. “This measure acts as a deterrent, incentivising prompt payments and creating a more equitable business environment,” he asserts.
“Meanwhile, it also has the potential to alleviate financial constraints for MSMEs by ensuring timely settlements. Timely payments can enhance liquidity, foster trust in business relationships, and enable MSMEs to meet operational needs promptly. Ultimately, reducing delays can positively influence the overall business environment for MSMEs, fostering a more sustainable and growth-oriented landscape,” he adds.
The Federation of Indian Micro and Small & Medium Enterprises (FISME) also agrees. “The provision strengthens MSMEs’ positions when negotiating payment terms with larger companies. Timely payments can minimise potential disputes and legal hassles over outstanding dues. It encourages more transparent and accountable business practices in the MSME ecosystem,” it says.
Challenges and calls for adjustment
However, potential unintended consequences may arise. Possibly in the initial stages. In fact, the initiative hasn’t been devoid of challenges and calls for adjustment.
Industry bodies such as the Confederation of All India Traders (CAIT) had sought its postponement due to lack of clarity and the Clothing Manufacturers Association of India (CMAI) had raised concerns over its implementation timeline. Additionally, exporters have sought exemptions, citing potential liquidity constraints due to the average time lag in receiving export proceeds.
Also, medium and small enterprises would face some additional obstacles at the ground level.
Challenges may arise from cash flow constraints, disputes over invoices, complex approval processes, and technological limitations. Cash flow issues may hinder timely payments, while disputes and inefficient processes can lead to delays.
Companies could opt to renegotiate contracts or limit engagements with MSMEs to sidestep penalties, potentially hindering collaborations between large and small businesses. MSMEs are already witnessing a rise in the number of order cancellations.
This has instilled a new fear—what if large enterprises leave genuine MSME suppliers and choose to go with non-MSMEs or those businesses that are not registered with UDYAM.
The FISME contends, “Replacing dependable suppliers just because a large company does not want to pay them on time is a ridiculous conclusion to draw. In any case, in the worst eventuality, the tax thus paid over such delays can be adjusted the following year when the company pays the supplier. But it does instill discipline in commercial practices.”
Striking a balance between enforcing timely payments and maintaining a flexible business environment is crucial to avoid unintentionally impeding economic partnerships.
Compliance will pave the way
What about its effectiveness, we ask.
“The effectiveness of timely payments to MSMEs depends on its enforcement and the commitment of the involved parties,” answers Shah.
“While it signals a positive step towards addressing cash flow issues for MSMEs, challenges may arise in implementation. Some businesses may struggle to adapt to the new payment terms, potentially leading to resistance or delays. Monitoring and enforcing compliance across diverse sectors and geographies could prove challenging. Additionally, economic uncertainties or disruptions may impact the ability of larger entities to meet payment obligations promptly,” he elaborates.
“Large firms and government ministries are encouraged to adopt efficient processes to comply with the 45-day rule. The phased implementation suggested by industry advocates could provide a transitional period for these entities to adjust their internal processes, thereby reducing potential disruptions and ensuring smoother compliance,” Desai suggests.
Apex bodies such as the Clothing Manufacturers Association of India, underscore the need for sufficient adjustment time, highlighting the balance between enforcement and practical feasibility for all the parties involved.
Another way to ensure compliance is the inclusion of robust measures. These include staying updated on local regulations, clearly outlining payment terms in contracts, automating payment processes, fostering effective vendor management, and conducting regular internal audits. “Clear communication, training on legal obligations, and establishing escalation procedures are essential components in maintaining adherence to the 45-day payment rule,” says Shah.
Beyond the immediate impact, sustaining support for MSMEs necessitates a holistic approach encompassing digitalisation, financial education, and regulatory frameworks. Drawing insights from international examples like the UK’s Prompt Payment Code and Australia’s Small Business Ombudsman offers valuable lessons for India in fostering a culture of prompt payments to small businesses.
The directive introduced in the Finance Act 2023 is a pivotal step towards empowering MSMEs through timely payments. While challenges persist, concerted efforts from stakeholders across sectors can pave the way for a more resilient and inclusive economic landscape, where MSMEs thrive as pillars of growth and innovation.
