About a week back, the Supreme Court dismissed a petition filed by traders’ and manufacturers’ bodies against Section 43B (h) of the Income Tax Act; it asked them to direct their pleas to their respective high courts. This Section, introduced in the FY24 Budget, says that if dues to SMEs are not settled within 45 days (a limit set under Section 15 of the Micro, Small and Medium Enterprises Development Act, 2006), the debtor concerned cannot claim a tax deduction in that particular financial year. It is deductible only in the year in which the dues are settled.

While this does not seem like a matter for the apex court, the petitioners had sought to raise a constitutional question — on whether the conditions under Section 43 negate commercial and contractual freedoms. Be that as it may, Section 43B (h) is no doubt meant to ease the perennial working capital concerns of MSMEs. But it runs the risk of harming MSMEs’ business, as it does not take into account the ground realities with respect to supply chain flows and finance. The 45-day credit window seemed arbitrary and unrealistic anyway, even when the expense was deductible on an accrual basis. To get around this, market actors devised their own strategies. Cheques are issued, recorded in the books and not ‘presented to the bank’ by mutual consent, to get around the 45-day rule, clearly showing that the market demands a credit period that is perhaps closer to 180 days (the time allowed to close a transaction under GST to avail of input tax credit). MSMEs play along, fearing loss of business to others who offer better credit terms.

This is not to say that MSMEs should be reconciled to the harsh logic of the credit market. What they need is access to cheap working capital. There are a few ways to achieve this. First, those procuring and supplying to reputed companies should be able to avail finance at rates similar to their top rated clients. Second, banks should be asked to devise a system of financing raw material suppliers to MSMEs such that they don’t demand upfront payments. Third, as the 2019 UK Sinha committee report on MSMEs observes, banks should move away from balance sheet-based lending to leveraging the cash flows of a unit, based on turnover and GST data. This could open up credit access for MSMEs whose cash flows are reliable, even if their collateral is not adequate. Fourth, the Trade Receivables electronic Discounting System, or TReDS, should be strengthened.

In the absence of the first three steps, the cost of discounting bills could rise sharply for MSMEs. It should be recognised that the supply chain financing squeeze happens most in the middle of the chain, as the large firms at the apex have considerable leeway in scheduling orders and paying for them. All this only tells us that market-based solutions work where legal diktats don’t. This is only too easily forgotten.