45-day SME payment rule aims to ease working capital issues, faces hiccups

It has been three months since the 45-day payment rule for micro and small enterprises (SMEs) was implemented. Introduced last year through the Finance Act of 2023, the rule, which came into effect on April 1, aims to address the working capital shortages that SMEs face by ensuring they get paid within a stipulated timeframe. 

This amendment to the Income Tax Act, brought about through Section 43B(h), mandates companies to settle payments to SMEs within 45 days. Failure to do so results in a denial of tax deduction on the overdue amount until the payment is made.

For SMEs, which play a significant role in job creation and exports, this is a welcome move. However, the going has not been smooth. 

The industry remains divided, with some sectors opposing the 45-day payment cycle and demanding the finance minister reconsider it in the upcoming Budget. While many SMEs support the amendment, some fear it might lead to big businesses shunning them and moving their orders to unregistered SMEs.

As of December 2023, over 30 million MSMEs are registered in the country, according to government data. This includes medium enterprises, though the 45-day clause applies only to micro and small enterprises. Services form the largest segment of MSMEs. The average payment cycle has traditionally been 90 days, which the new rule halves.

While interacting with MSMEs in Ludhiana, Punjab, in May this year, Finance Minister Nirmala Sitharaman said that if MSMEs preferred to operate with uncertain payment timelines, the government would repeal the changes. This statement followed concerns from some SMEs, including those under the Clothing Manufacturers Association of India, about losing business to other suppliers.

Sumit Singhania, a partner at Deloitte India, noted that while the tax deductibility change aimed to encourage timely cash flows for SMEs, its implementation had brought several issues to the fore. “Payers are subject to various commercial aspects in addition to ensuring SME eligibility, such as performance-based retentions and provisional year-end accruals/expense bookings," he explained.

Give and take

Traders and associations related to food and clothing sectors opposed the rule, citing longer payment cycles from their buyers. 

Suresh Agrawal, president of the All India Dal Mill Association, said the association had expressed strong opposition to the 45-day rule during the pre-Budget consultation with Sitharaman. 

“In rural areas, the clothing business has a payment cycle of 90-120 days. The furniture plywood and dal (pulses) industries have payment cycles of 50-60 days,” he said. “If we do not get payments within 45 days, how will we pay further?"

Clause 43B(h) stipulates that starting from the assessment year 2024-25 (financial year 2023-24), expenses on invoices from micro and small enterprises can only be claimed if paid within 45 days where an agreement exists, and within 15 days if there is no agreement.

VP Vaishnav, president of the Rajkot Chamber of Commerce and Industry, argued that exporters should be excluded from the payment cycle, as most payments are made against documents and letters of credit, involving a 120-day transaction cycle. 

“We request a level playing field for Indian exporters compared to those from other countries. If not exempted, the 45-day cycle should be increased to 120 days," Vaishnav said.

BC Bhartia, national president of the Confederation of All India Traders (CAIT), said SMEs dealing with retail can't get payments in 45 days and need more time. “It is easier for those who deal directly with companies, as they can get payments on time," he added.

Time-ly intervention

Most SMEs have, however, welcomed the rule change. 

"The 45-day payment rule is a boon for small and micro enterprises. We are now seeing timely payments, which help us pay labour and invest in new equipment," said Vinod Karwa, chair of the MSME Committee at the PHD Chamber of Commerce and Industry.

Ashok Saigal, co-chairman of the CII National MSME Council, added, “Our findings indicate that manufacturers and enterprises are very happy with this clause.” He said that small and micro manufacturers had reported no loss of business due to this rule

India SME Forum, a not-for-profit for small and medium businesses, conducted a survey of its 102 council members. It found that 93 supported the new rule, five suggested modifications, and four wanted the Income Tax amendment dropped. 

"Delayed payments have been a curse for SMEs. This provision in the IT Act is a timely step by the government and will be highly beneficial to India’s micro and small entrepreneurial ecosystem," said Vinod Kumar, president, India SME Forum. He added that the forum had been trying to get buyers to adhere to the 45-day limit for two decades.

On June 18, Business Standard reported that the Ministry of Micro, Small and Medium Enterprises had received positive feedback from the industry regarding the 45-day payment cycle. That said, an official noted that any change in the Finance Bill was the prerogative of the finance ministry.

How the finance minister addresses the opposing concerns in the upcoming Budget will be keenly watched.

Status check

* Delayed payment applications by MSMEs since October 2017: 197,000 

* Total cases filed in MSE Facilitation Council: 82,275

* Cases disposed: 41,652

* Amount involved in disposed cases: Rs 7,865.27 crore

* Amount payable: Rs 25,948.81 crore

Source: MSME Samadhaan

Know your MSMEs

Microenterprise: Investment in plant and machinery does not exceed Rs 1 crore; turnover does not exceed Rs 5 crore

Small enterprise: Investment does not exceed Rs 10 crore; turnover does not exceed Rs 50 crore

Medium enterprise: Investment does not exceed Rs 50 crore; turnover does not exceed Rs 250 crore