Delayed Payments Are The Bane Of Indian MSMEs, Latest IT Rule Is Unlikely To Help

Vikram Mittal, the co-founder of MAVI’s Pantry, a small company that manufactures fermented products like Kombucha and Kimchi, was elated when a large Mumbai-headquartered Indian conglomerate placed an order with his company in April 2023. While this was an opportunity for visibility and business growth, it did not end well for the company.

Mittal had to spend months chasing after payments. A year later, he still hasn’t received the entire amount promised for the order. “They wanted us to deliver the order urgently for an opening of a place and they didn't pay us for almost six to eight months. Later, they only paid the pre-tax amount,” Mittal told The Core.

This is not an isolated case. Micro, small and medium enterprises (MSMEs) often have to wait long periods to get payments, often hampering cash flow to the businesses. It is not just private players who are guilty of delaying payments, public service units (PSUs), ministries and state governments too are defaulters.

Neeraj Khedia, chairman of the Banking and Finance Committee, Federation of Indian Micro and Small & Medium Enterprises, said that he was forced to file a case at the Patna High Court in 2010 when the Bihar State Agro Industries Development Corporation failed to pay his company, Chakradhar Chemicals Pvt. Ltd.

“Despite the high court order, the PSU didn’t clear the due payments and my business faced severe losses. Thankfully, I had financial backing from my family members, who helped me sustain the business,” said Khedia.

Like Khedia, Mittal too has had to borrow from family to keep his business afloat.

Buyers must pay MSMEs within 45 days of goods or services provided, according to the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006. But this has done little to stop buyers from defaulting on their payments. According to data from the MSME Samadhaan portal, the total outstanding amount owed to MSMEs in India as of April 2024 exceeds Rs 20.7 thousand crore. The portal is a delayed payment monitoring system set up by the government.

Now the Income Tax (IT) department has introduced a penalty on buyers effective from April 1. The new rule prevents businesses from claiming tax deductions for payments made beyond 45 days to MSMEs for the supply of goods and services. As the new rule kicks in, stakeholders aren’t too hopeful and expect little change. Delayed payments are a major factor that affects the working capital of MSMEs, often leading businesses to shut down because of losses.

IT Rule Won’t Tip The Scales

According to Section 43B(h) of the Income Tax Act, introduced through the Finance Act of 2023, if a larger company fails to pay an MSME within 45 days (as stipulated in written agreements), it cannot deduct this expense from its taxable income, potentially leading to higher taxes.

KE Raghunathan, national chairman of the Association Of Indian Entrepreneurs believes there are ways to go around this rule. “While a loss-making large enterprise might not have any IT obligations, the big conglomerates might find ways to tamper with the details of due payments to MSMEs on their books. After all the expense disallowed this year due to default gets accounted as expense next year when paid."

The IT rule will not apply to government departments or ministries that are not mandated to pay income tax like the Indian Railways, nor is it applicable to other companies and enterprises that don’t come under income tax purview.

The tax rule does not directly benefit MSMEs either.

“The supplier whose payment is delayed doesn't get any relief and instead the government gets additional revenue from the income tax receipt from the defaulter. Thus, the MSME is not getting benefitted directly,” Raghunathan said.

A co-founder of a fintech company with a sizeable SME clientele, on condition of anonymity, said that sometimes large companies too have their own set of challenges in making payments. The acquisition of raw materials or intermediary goods for manufacturing within a large company poses a notable challenge. Such inventory may need to be retained for an extended duration before it can be sold to customers. “So there is some genuine challenge even for a large company. Then it is very simply capital allocation, at the large company level.”

For large conglomerates, the co-founder said, the problem could be simply that of inefficiency. “They pay their executives fat salaries at the expense of capital efficiency in other parts of the business or they have kind of ventured into certain new areas which are still not paying off. So they are finding it difficult to allocate capital properly for this,” they said.

No ‘Samadhaan’ For Working Capital

Due to payment delays, MSMEs face significant challenges in managing their working capital. They cannot seek working capital financing from banks or pursue legal action against large corporations or the government due to financial and procedural constraints. Under the Pradhan Mantri Mudra Yojana (PMMY), MSMEs can access collateral-free loans up to Rs 10 lakh. However, two main challenges persist: banks are often hesitant to provide collateral-free loans, and the amount offered may be insufficient for companies grappling with working capital shortages.

“It is not possible for micro and small enterprises to have the collateral. Banks usually ask for fixed deposits, bonds or properties as collateral and a business, which is already in a struggling phase might not have them,” said Vinod Kumar, president of the India SME Forum, an association of Small and Medium Enterprises.

The MSME Samadhaan portal was supposed to be one of the solutions to the problem — a one-stop shop where small businesses could find recourse. “You won’t have a lack of working capital, your money won’t get stuck and your cash cycle won’t break,” Prime Minister Narendra Modi had promised during an event in 2019.

As of April 2024, there are over 85,000 such pending cases and applications.

Large enterprises and PSUs continue to disregard the 45-day payment rule as they don’t face penalties for delayed payments.

A facilitation council — set up to serve as a conciliator or arbitrator for settling outstanding dues between parties and convene monthly meetings — has failed to be effective. “The facilitation council has not functioned the way it should have functioned. The loophole in the previous mechanism was that there were no teeth for the enforcement of that decision (45-day payment). The facilitation council was not effective and MSMEs have to go to the courts (for payment clearance),” said Ashok Saigal, co-chairman of the Confederation of Indian Industry (CII) National MSME Council.

State governments and PSUs make up a significant portion (40%) of defaulters in payments to MSMEs. The Core reached out to the MSME Samadhaan portal to understand what causes the delays and will update this story upon receiving a response.

Legal Action Solves Little

Filing a legal case is often a last resort for MSMEs, but it provides little guarantee that a payment will come through. Take for example the case of Amit Jain of Dayachand Engineering Industries Pvt Ltd, a manufacturer of steel electrodes and tubes. The company has been awaiting payment from Heavy Engineering Corporation Limited, a CPSU, since 2013.

“It has been 11 years and I am yet to receive the full payment. HEC officials informed the MSEFC Kanpur that due to paucity of funds, the payment was not made. Had it been a private company, then even the courts would perhaps have executed the decree with greater urgency, and fear of the law could have it's effect,” said Jain.

Small companies often don’t file legal cases because they want to continue to get business from bigger companies. They also fear boycotts or losing business. There have been instances when big companies have compelled smaller ones to deregister themselves from the MSME portal so that they don’t come under the purview of the MSME Act.

“Even if the bigger company doesn’t want to pay the MSME, they still book the bill and show during tax filing that it was a part of my expense, even though the payment has not been cleared. So, there is a fallacy,” said Kumar. He claimed that nearly 14,000 MSMEs have been forced by large enterprises to deregister themselves from the MSME portal.

The MSMEs The Core spoke to highlighted a list of problems that going into legal battles comes with — large monetary costs, travelling to different cities for court hearings and waiting years for the case to close. Often even court directives don’t result in the payment coming through.

“I filed a case against the Indian Railways for the payment delay in 2014 at Kanpur Court. Now the consignee (buyer) can either pay directly to the MSME or to the court. Kanpur Court told me that I need to visit the city court, where the office of the Indian Railways is based. Recovery needs to be done from that state. I then appealed to the Allahabad High Court and they ordered the payment in Uttar Pradesh only. I have still not received the full payment,” said Rajiv Kumar Saini, who owns a service provider company of electronic engineering, industrial engineering and plant design.

Also Read: 10 Years Of PMJDY Couldn’t Get India’s Women Included In Banking. Phones Were The Problem