The Supreme Court recently asked a group of MSME industry associations to petition the High Courts regarding Section 43B(h) of the Income Tax Act, 1961. It may seem counter-intuitive that the clause, inserted in the FY24 Budget to promote timely payment to MSMEs, has been challenged by MSMEs themselves. The section mandates that expenses in this regard are deductible in the relevant financial year upon actual payment, not when due, starting from assessment year 2024-25. However, this provision faces challenges stemming from unintended consequences and practical realities. Many MSMEs have experienced avoidance of purchases from them. To safeguard their sales, some of them have changed their status to traders while others cancelled their Udyam registration.

Historically, leniency in penal interest on delayed payments to MSMEs under the MSMED Act 2006 persists due to MSMEs’ reluctance to demand it, fearing a disruption in business relationships. Contrary to 45 days upper limit, buyers can even now significantly extend payment periods with impunity as in practice very little penal interest is paid on delayed payments and the Section 43B(h) applies only to year-end outstanding overdue to MSMEs.

The extended period can be anywhere between 364 days and 46 days for purchases made between April 1 and mid-February, respectively, and settled by the year-end. The year-end MSME payments bunching creates asymmetrical payment flows, bank credit utilisation, and overall business operations across firms.

Timely repayment is the lynchpin of sustainable lending and a thriving credit ecosystem. However, MSMEs continually grapple with payment delays, defaults, and backlog of receivables despite a long history of well-intended legal and regulatory safeguards, disclosure mandates (dating back to 1993 and 2006) and initiatives like Samadhan, TReDS, and RBI advisories to address the issue. A Dun & Bradstreet survey (May 2022) estimated that ₹8.6 trillion is annually struck in delayed payments to MSMEs. Brickworks Ratings [June 2020] reported ₹3.3 trillion delayed payments to MSMEs by the 760 largest corporates by market capitalisation.

Way out

The asymmetrical power equation between buyers and MSMEs disadvantages smaller suppliers, necessitating an integrated market-driven payment discipline mechanism with real-time monitoring of late payments. Leveraging the GSTN network as a data-sharing platform for B2B credit sales and repayments enables this. This requires:

Incorporation of payment due date and payment receipt date fields in the GSTN portal.

Auto-graded red-flagging of trade debtors’ GST accounts on the 11th, 21st, 31st, and 61st days for overdue payments, categorised as 1st, 2nd, 3rd, and 4th red-flag, respectively. Late payments after 60 days incur monetary penalties, with a risk of GST account suspension after 90 days.

The third red-flagging triggers digital credit default report’s auto-transmission to CIBIL, concerned banks, Ministry of Corporate Affairs, and stock exchanges. This impacts the perception of a firm’s credibility and reputation with market, credit rating agencies, investors, bankers and vendors. Real-time engagement of these multiple stakeholders enhances oversight, enforcement efficiency, and market discipline in payments.

Implementing the proposed strategy in stages, starting with firms with annual turnovers exceeding ₹500 crore, followed by those exceeding ₹300 crore, ₹100 crore, and eventually extending to all GSTN-registered firms, provides adjustment time for smaller firms and enhanced liquidity circulation.

Regarding trade credit tenure, it could be gradually decreased from 120 days. However, prioritising the assurance and reliability of timely payments over arbitrarily shortening the payment period is a better idea. Certainty in timely payments fosters bill discounting, credit sales, and efficient funds planning. Intense competition to discount bills of vendors of top-rated companies underscores how assured timely payments can boost bills discounting in general.

Timely realisation of receivables enhance its collateral value, reducing the need for asset collateral. These bolster cash flow-based lending and bill discounting. These boost transaction volume, liquidity circulation, and credit velocity and lower receivable management costs, while minimising business failure risks. Streamlined repayments benefit business operations, while helping real-time detection of financial distress can aid in improving NPA and banking credit fraud management, and potentially reducing NCLT workload as majority of the NCLT cases relate to operational creditors.

Exploring alternatives to current MSME payment regulations, particularly within the GSTN digital framework, is crucial.

The writer is former DGM, SIDBI