On 6 May 2024, Micro and Small Enterprise (MSE) traders received a setback when the Supreme Court declined to hear their plea against the new Income Tax provision, allowing MSEs to pursue their case in the High Court. The petition sought an interim stay and quashing the amendment in the Income Tax Act prescribing that companies not making payments to micro and small enterprises during a fiscal year will have to wait for a full year for deductions under the IT Act.

To promote timely payments to MSEs, a new clause (h) in Section 43B of the Finance Act 2023 was inserted to provide that any sum payable by the assessee (the buyer) to a MSE beyond the time limit specified in Section 15 of the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 shall be allowed as deduction only on actual payment. The Union Government has repeatedly stressed that the amendment is meant to ensure timely payment to micro and small businesses and to help them.

Anil Bhardwaj, Secretary General, Federation of Indian Micro and Small & Medium Enterprises (FISME), observes, "The amendment under 43B are additions to two already legal provisions for MSEs: delayed payment provisions under MSMED Act and MoCA Notification dated 11 October 2018 requiring Companies to 'disclose’ outstanding payments separately under MSE and other heads in Schedule VI of Balance sheet. Companies have been already dealing these requirements. The new amendment, Section 43B(h), requires payment to be made within 15 days without any agreement and within 45 days with agreement. In case it not adhered, the outstanding amount would not be allowed as expenses and treated as income."

The provision was announced in Budget 2023 to take effect from FY 2023-24. “This was perceived to be a welcome step by micro and small enterprises, as it was intended to help them in tackling the working capital crunch. However, towards the end of FY 2023-24, the micro and small enterprises started finding themselves dealing with a peculiar problem. The large and medium enterprises (buyers) either started cancelling orders with the registered MSMEs and placing these orders with unregistered MSMEs, or forcing the micro and small enterprises to forsake their registrations as micro or small enterprises under the MSMED Act, 2006, exercising their financial influence. This is leading to major loss of revenue to the micro and small enterprises," states Yogesh Kale, Executive Director, Nangia Andersen India.

Boon turns into a bane
In the interim budget on 1 February 2024, companies were expecting the government to change or postpone the rule for 2023-24. However, nothing was announced. "Many were expecting a relaxation of the payment terms before the budget. However, after the budget was announced with no changes, panic ensued," says Baljit Singh Bedi, Chairman, Association of Entrepreneurs (AOE).

Another issue is the interest on delayed payments. "If payments are not made on time, interest will accrue. Many are unaware of this clause. Auditors will need to highlight this, and ask companies to make provision for the interest (if any)," adds Bedi.

It is no doubt that the MSEs are now feeling the squeeze from Section 43B(h). Palak Ratwani, Legal Associate, SRGA Global, observes, "The tighter payment deadlines are throwing a wrench into their cash flow plans. The new rule could impact relations between suppliers and buyers who often work with these small businesses on a credit system. Industries like textile, automobile, agro-based sector, etc, which are largely dependent on micro and small businesses, may face severe financial and regulatory challenges. Considering the implications, businesses may tend to prefer medium enterprises, resulting in a loss of business for MSEs. Many MSEs may be willing to work with a larger credit period, with a commercial interest of big business opportunities and business volume. However, the regulatory change, supposed to be a boon, is turning out to be a bane for them."

The reason why concerns are being voiced now, as opposed to earlier, is due to the enhanced understanding and clarity businesses have gained through detailed clarifications. “As these clarifications provided a clearer picture of the practical implications of Section 43B(h), more MSEs recognised the potential negative impact on their operations,” she informs.

Rahul Mehta, Chief Mentor, The Clothing Manufacturers Association Of India (CMAI), adds, “This move by the government, to implement Section 43B(h), was intended to protect MSMEs and benefit them by reducing their buyers' payment cycles, thereby improving their financial positions. However, the government failed to consider that payment cycles vary from industry-to-industry and took a uniform approach, applying this rule to all MSMEs and industries. For example, in the textile industry, the typical payment cycle is between 90-180 days. For garment retailers, changing their entire payment and business cycle from 120 to 45 days at one stroke was an enormous task, virtually impossible given the current financial situation. A phased payment schedule, reducing it to 90 days in the first year, 60 days in the second year, and 45 days in the third year, is recommended by CMAI and supported by various associations and industry bodies.”

MSEs wholeheartedly welcome the government’s commitment to fostering an ecosystem where payments to MSEs are made promptly. However, the stringent section is deterring buyers from doing business with MSEs and are instead buying from medium & large enterprises. “While our issuer does not classify under MSME, the general sense, after discussion with issuers, who have longer payment cycle, is that these issuers may replace MSME with non MSME suppliers which will let them enjoy longer payment cycle and also helps avoid compliance related cost in this aspect,” observes Abhash Sharma, Senior Director & Head - Emerging Corporates, India Ratings & Research.

Baljit Singh Bedi adds, “The MSE sector is experiencing significant difficulties, as they are losing orders and their customers are also facing challenges. This creates a complex situation for both buyers and sellers. Buyers, who are accustomed to longer payment cycle, now find it difficult to make payments within one and a half months.”

According to Rajiv Chawla, Chairman, IamSMEofIndia, section 43B(h) is not applicable to government agencies like Indian Railways, Ministries and municipalities/corporations, etc who account for a major share in MSEs’ orderbook. “On the other hand, MSE buyers (if they are sourcing products/services from other MSEs) also come under it. So, while government agencies continue to follow their old payment cycle, it affects MSEs for whose benefit the section was added,” he says.

K E Raghunathan, National Chairman, Association of Indian Entrepreneurs, opines, "After this order came into force many orders on MSMEs especially ancillary units have been withheld or cancelled. Many corporates are forcing suppliers to cancel their MSME registration. Traders have been excluded from this act, even though they are part of MSMEs. The supplier whose payment is delayed doesn't get any relief and instead the GoI gets additional revenue from the Income Tax receipt from the defaulter. A buyer, who has received a service or supply from an MSE in April this year but pays only by March next year, is not on the radar as a defaulter. This amendment must be scrapped as it doesn't resolve the main issue at all.”

Challenges before the buyers
It is not that only micro and small enterprises are facing problems, there is another side of the coin. “While this amendment aims to instil financial discipline, and safeguard micro and small enterprises against delayed payment, its impact is felt hugely by the buyers who are classified as large or medium enterprises. The amendment places added pressure on the buyers, particularly the ones that are operating on thin margins and constricted working capital, to manage their cash flow effectively. Though the buyers are now in a way compelled to pay the MSEs in the prescribed time, on the other side, there is no assurance of timely collection from customers, unless the buyers are registered MSEs themselves," explains Yogesh Kale.

For example, manufacturing companies heavily reliant on MSMEs for raw materials and ancillary services may experience disruptions in an attempt to avoid additional tax liability that may be triggered by virtue of section 43B(h). “Similarly, service industries, including IT and hospitality, may encounter cash flow constraints, impacting their ability to meet operational expenses and invest in growth initiatives," he says.

Section 43B(h) of the Income Tax Act poses significant challenges for medium and large companies, particularly in how they manage and process invoices related to the purchase of goods. It stipulates that any sum payable to a supplier must be paid within 45 days from the date of the invoice. However, this timeline does not always align with the practicalities of business operations, especially in industries like manufacturing.

"One major challenge is the discrepancy between the invoice date and the actual acceptance of goods. In a manufacturing setup, the process often involves a delay between the delivery of goods, the generation of the invoice, and the acceptance of the goods after passing quality checks. Typically, a manufacturing company might receive goods and an invoice simultaneously, but they only consider the goods officially received and accepted after a rigorous quality check. This quality check could take several days or even weeks, creating a gap that Section 43B(h) does not account for,” observes Palak Ratwani.

She adds, "Furthermore, the entire supply chain involves substantial time in moving goods from the manufacturer to the end seller. During this period, various logistical and procedural steps need to be completed, each taking time and potentially delaying the acceptance of goods."

Also, Section 43B(h) only supports the micro and small sectors, not the medium sector. Rahul Mehta explains, “Retailers now prefer buying from medium or large enterprises because they cannot afford to pay within 45 days. Consequently, while the payment cycle may have become faster, overall business has shrunk. This has led to a significant number of MSMEs deregistering themselves before 31 March, as buyers want to deal with non-registered MSEs. Implementation of Section 43B(h) has resulted in massive returns, a large number of order cancellations, and a shift from micro and small to medium and large enterprises. Thus, the MSME sector has been hurt more than benefited.”

In addition, some buyers, to adhere to the new payment rule, are asking MSE manufacturers to route their supply through distributors or traders. In this case, though MSEs are getting payment on time, distributors/traders are charging a premium thus increasing their cost. This is further complicating the situation.

Break-up of companies who have cancelled their Udyam registration

Contrary views
Federation of Indian Micro and Small & Medium Enterprises (FISME) holds a contrary view and has strongly welcomed the implementation of Section 43B(h). Anil Bhardwaj elaborates, "The apprehensions some people have about Section 43B(h) are absolutely unwarranted. This particular provision applies only at the close of the balance sheet on 31st March. I would suggest all companies to review their balance sheets by 15th February and settle their dues. If they lack funds, it's not a significant issue; some tax will be charged, and they will receive reimbursement when the payment is made. This provision benefits the industry, although some traders might face challenges."

According to him,

• The Income Tax Amendment gets triggered on balance sheet date i.e. 31st March. So only those bills that are pending for payment on that day are covered. The transactions during the rest of the year have nothing to do with the amendment. Therefore, whether somebody has delayed payment will be treated under existing provisions of MSMED Act as in past. No change.
• In case the company fails to adhere payment to MSE criteria in March (15 or 45 days as the case may be), the company will make provision for Income Tax as applicable. But in that case also, once it pays the supplier next year, it could claim refund.
• Traders are not covered under MSMED Act provisions other than priority sector landing, the amendment should not affect them.

“While there may little bit of adjustment required, there is no need of panic whatsoever. The doomsday scenario on social media is totally unwarranted,” he adds.

There is no penalty for delaying the payments to MSEs during the financial year if the payments are settled by March 31, 2024. It means buyers must clear all invoices received from MSEs from 1 April 2023 till 16 February 2024 (where agreement exists) and upto 17 March 2024 where no agreement exists. "In a nutshell, delay allowed on purchases in the first three quarters and timely payments only for the purchases made in the last quarter. Overall, still very much in favour of buyers," said Rajiv Chawla, in his post on 19 February 2024.

New government, new modifications
The industry associations have approached the government with their grievances and they expect some measures to be taken to mitigate the challenges posed by Section 43B(h) and to lead to smoother operations and better compliance. Palak Ratwani informs, “From the policy perspective, a modification in Section 43B(h) may provide a more practical solution. The government could revise the rule to allow the 45-day period to begin from the date of acceptance or acknowledgment of goods and services, rather than from the invoice date. This change would better reflect the realities of business operations and ensure that companies are not penalized for procedural delays that are beyond their control.”

She suggests following modifications to Section 43B(h):

• Providing flexibility in payment timelines while still ensuring timely payments to MSEs. Extension of compliance timeline to further one year.
• Conducting a comprehensive review of the amendment's impact on businesses of all sizes to inform any modifications effectively.
• Consider extending the payment timeline under Section 43B(h) from 45 days to 60 days to accommodate operational realities and ease compliance burdens for businesses.

Rahul Mehta opines, “At CMAI, we believe this move is beneficial in the long run. However, two issues need to be addressed: all segments (including medium enterprises and traders) should be covered, and the implementation should reflect ground realities. We hope that once the new government is in place in June 2024, we can advocate for adjustments to ensure a more phased implementation. It is in our interest to reduce payment cycles.”

Raghunathan wants the government to make bill discounting as mandatory on regular supplies between the buyer & the seller. "As per the agreed time frame, the buyer bank can make the payment to the supplier bank on the due date and also report defaulter to the government directly. This will save the MSME owner being exposed for such complaints,” he observes.

Some experts believe that laws, including Section 43B(h), should allow buyers and sellers to determine their own payment terms. "Each trade has unique needs. For instance, in the case of capital goods supply, a buyer and seller might agree on an initial 50 per cent advance payment, followed by the balance after 6 months of trials and testing. Therefore, legal frameworks should accommodate flexible payment terms, considering market dynamics and sector-specific variations. These laws should be robust and swift in addressing breaches of agreements rather than deciding payment terms and tenure," says Rajiv Chawla.

He wants to extend the applicability of the 43-B Amendment to payments made to medium enterprises. "This will ensure equitable treatment of micro, small, and medium enterprises by buyers, preventing a preference for medium enterprises solely due to payment terms, he explains.

It is clear that the introduction of Section 43B(h) has disrupted the status quo and the new Union government may need to revisit the provision with a myopic eye after the elections.

With Finance Minister Nirmala Sitharaman, in a media interaction on 28 May 2024, hinting at the Centre’s willingness to reconsider the 45-day payment rule for micro & small enterprises (if the industry wants it), one can expect some modification or relief in the July budget.

Anil Bhardwaj, Secretary General, FISME

The apprehensions some people have about Section 43B(h) are absolutely unwarranted. The Income Tax Amendment gets triggered on balance sheet date i.e. 31st March. The transactions during the rest of the year have nothing to do with the amendment.

Yogesh Kale, Executive Director, Nangia Andersen India

Though the buyers are now in a way compelled to pay the MSEs in the prescribed time, there is no assurance of timely collection from customers, unless the buyers are registered MSEs themselves.

Baljit Singh Bedi, Chairman, Association of Entrepreneurs

The MSE sector is experiencing significant difficulties, as they are losing orders and their customers are also facing challenges. This creates a complex situation for both buyers and sellers.

Palak Ratwani, Legal Associate, SRGA Global

The tighter payment deadlines are throwing a wrench into their cash flow plans. The new rule could impact relations between suppliers and buyers who often work with these small businesses on a credit system.

Rahul Mehta, Chief Mentor, CMAI

Implementation of Section 43B(h) has resulted in massive returns, a large number of order cancellations, and a shift from micro and small to medium and large enterprises. Thus, the MSME sector has been hurt more than benefited.

Abhash Sharma, Senior Director & Head - Emerging Corporates, India Ratings & Research

Issuers, who have longer payment cycle, may replace MSME with non-MSME suppliers which will let them enjoy longer payment cycle and also helps avoid compliance related cost in this aspect.

Rajiv Chawla, Chairman, IamSMEofIndia

MSE buyers (if they are sourcing products/services from other MSEs) also come under it. While government agencies continue to follow their old payment cycle, it affects MSEs for whose benefit the section was added.

K E Raghunathan, National Chairman, Association of Indian Entrepreneurs

The government must make bill discounting as mandatory on regular supplies between the buyer & the seller. As per the agreed time frame, the buyer bank can make the payment to the supplier bank on the due date.