The Msme Conundrum: Making All Sizes Fit One!

With a rapidly growing economy like India, the crucial role of micro, small and medium enterprises (“MSMEs”) cannot be overstated.  It is for these reasons that, from time to time, laws and amendments are introduced by the government to ensure that money reaches every corner of the society, nurturing growth and improving opportunities for all stakeholders, especially the smaller scale businesses, namely, the MSME Sector.  Recognizing the pivotal role of MSMEs, The Micro, Small and Medium Enterprises Development Act, 2006 (“MSME Act” or “Act”), was enacted on 16 June 2006.  The coming into effect of the Act led to the merger of the erstwhile Ministry of Small Scale Industries and the Ministry of Agro and Rural Industries, forming the Ministry of Micro Small and Medium Enterprises (“MoMSME”)[1].

Whilst MoMSME was created to design policies, schemes, and continually evaluate its implementation (all with the aim of fortifying the ecosystem for MSMEs), the Act aimed at facilitating promotion, development, and enhancing competitiveness for MSMEs.  Notably, the Act aimed at resolving the pervasive challenge faced by MSMEs: the issue of delayed payments to suppliers, and the arduous process for recovery.  Chapter V of the Act specifically deals with this issue; it imposes a statutory obligation[2] on buyers to make payment to their suppliers within fifteen (15) days, or within a period as may be agreed in writing, provided the said period does not exceed forty-five (45) days from the date of acceptance of goods or services by the buyer.  Failure to fulfill this obligation within the stipulated time period renders the buyer liable to pay compound interest (with monthly rests)[3], calculated from the day immediately following the expiration of fifteen (15) days from the day of acceptance of goods[4].  To enforce adherence to these provisions, and ensure payment of applicable taxes, lawmakers added Section 22 in the Act, which requires buyers to specifically state the principal amounts due to a supplier in their annual statement of accounts, and separately show the interest accruing over such amounts (in lines with Section 16 of the Act).

[1] Merged on 9 May 2007.

[2] Section 15 of the MSME Act.

[3] Section 16 of the MSME Act.

[4]  Defined as “appointed day” under Section 2(b) of the MSME Act.

As for countering the issue of recovery of dues of aggrieved suppliers, the Act provides for a mechanism for resolution of disputes between parties through conciliation, failure whereof leads to arbitration governed by the Arbitration & Conciliation Act, 1996[1].  To facilitate this process, the Act mandates the establishment of state-specific facilitation councils, namely, the Micro and Small Enterprises Facilitation Council (“MSMEFC”)[2].

Though, the Act, with its stringent provisions, was well intentioned and well crafted on the surface, glaring loopholes undermine its effectiveness.  One such loophole being that registration as an MSME is not mandatory.  The Act is rather silent on whether enterprises are to necessarily register as MSMEs, or whether benefits shall not be available to an enterprise that is not registered as an MSME.  Over the years, this confusion led astray enterprises into believing that they would be able to avail the benefits of the Act, only for them to be turned away at the doors of the MSMEFC, on the ground of non-registration.  However, the Hon’ble Supreme Court of India in the case of “Sipli Industries and Ors. v. Kerala State Road Transport Corporation and Anr.[3]”, clarified the said dilemma, holding that the benefits provided under the Act would only be available to MSMEs registered under the provisions of the Act, at the time of the transaction. 

Ever since the introduction of the Act, the jurisprudence surrounding MSMEs has evolved significantly, bringing about clarity to the interpretation of the Act, and awareness among business owners.  This led to many businesses getting registered as MSMEs with a justifiable understanding that the issue of delayed payments shall cease to exist.  As on date, there are more than 4 crore registered MSMEs in the country, 99% of which are micro and small enterprises[4].  However, with an increase in the number of MSME registrations, came practicality issues at the ground level.  As much as the law benefits the registered suppliers, the provisions thereof are particularly onerous to buyers.  The provisions not only mandate a buyer to make payment within 45 days, but it adds another liability altogether to pay compound interest onto the due amount at three times the bank rate, which equals to almost 20.25%.  What affects the buyers more is that they are to necessarily specify the accruing interest in their annual statement of accounts, which they cannot even claim as a deduction at the time of computation of income[5] under the Income Tax Act, 1961 (“IT Act”). 

[1] Section 18 of the MSME Act.

[2] Section 20 and 21 of the MSME Act.

[3] (2021) 18 SCC 790

[4] Factsheet of MSME Registration as available on the official website of the Ministry of Micro, Small & Medium Enterprises i.e., https://udyamregistration.gov.in/Government-India/Ministry-MSME-registration.htm

[5] Section 23 of the MSME Act.

Increasing the burden of liabilities on buyers, came The Finance Act, 2023, which inserted clause (h) under Section 43B of the IT Act.  This clause stipulates that any payments owed to MSMEs, not resolved within forty-five (45) days, will not qualify for tax deductions until the payment is actually made.  Effectively, this means that the new provision only allows for deductions upon actual payment, increasing the tax liability of larger companies.  The purpose behind the said amendment is to motivate larger entities to prioritize settlements with smaller entities registered as MSMEs.  However, the said amendment has not been well received by the public.  Various reports[1] indicate that representatives of trader bodies, such as Confederation of All India Traders (CAIT), have appealed to the Ministry of Finance for deferral of Section 43B(h) IT Act until April 2025, citing lack of clarity on the law’s applicability to traders, among other provisions.  The Clothing Manufacturers Association of India (CMAI) anticipates incurring losses of over INR 7000 crore in the January-March quarter due to the said amendment.  The crux of their issue appears to be the application and practicality of this amendment, which has cascading effects.  This amendment, in conjunction with the provisions under Chapter V of the Act, not only severely impacts the standard industry practice of credit cycles, which usually range between 90 days 180 days, but is forcing businesses to radically alter their long-standing business models to comply with the (45) day payment cycle, hence, leading to severe financial losses, and a significant increase in tax liabilities.  The expected consequence of this is the cancellation of orders with MSME registered suppliers, and return of unpaid-for-goods.  According to reports[2], larger companies are trying to circumvent this provision by cancelling orders with registered MSMEs or forcing suppliers to cancel their MSME registration.  In fact, companies now prefer to place orders with unregistered MSMEs, which allows a greater flexibility in operations.  Since larger companies exercise considerable negotiating heft against their MSME suppliers, this asymmetry in relations has resulted in a worrying regression: MSMEs choosing to deregister themselves to not lose out on business. 

[1] https://www.business-standard.com/finance/personal-finance/45-day-msme-payment-rule-impact-and-details-of-section-43b-h-explained-124032600333_1.html

[2] https://indianexpress.com/article/opinion/columns/msmes-are-not-paid-on-time-they-need-to-be-9312221/

Per Contra, the Federation of Indian Micro and Small & Medium Enterprises (FISME) understandably has a contrary view; since the amendment to Section 43B of IT Act only came into force after an entire year of its introduction in the Finance Act, 2023, people were given a full year to prepare, and everyone knew it was going to come into effect from April 1, 2024.  The said view is premised on the ground that the amendment shall instill discipline into commercial practices, and larger companies would learn to start paying in time. 

Needless to say, the aforesaid view, as well as the insertion of clause (h) to Section 43B, when in read in conjunction with provisions under Chapter V of the Act, are well intentioned, and shall instill a level of discipline in companies for clearing the dues of smaller companies.  However, the government should take a bird’s-eye view of the current situation since a conceptual framework significantly differs from its practical application.  Where there are businesses that have been operating for a long time under more flexible conditions with other enterprises, the imposition of such stringent laws, while seemingly aligned with the Act’s objectives, may be paradoxically undermining its intended goals.  As the Act does not make registration mandatory, smaller business owners are being left with no other option but to sacrifice their registration and the concomitant benefits in view of maintaining business relations with larger companies, and sustaining themselves.

The Act has been instrumental in promoting growth and development of small level businesses in India.  While the government’s ongoing efforts aim to tackle existing challenges and enhance the competitiveness within MSME ecosystem, it is imperative to heed the concerns raised by the businesses at-large (including those which are micro, small and medium). 

Exploring measures such as deferring the implementation of Section 43B(h) of the IT Act, enforcing mandatory registration, or reconsidering the current forty-five (45) day period of payment under the Act, are but a few options available to the government, demanding immediate attention. As we move ahead, achieving a delicate equilibrium between facilitating a conducive business environment whilst upholding regulatory standards will be pivotal in fostering growth and sustainability of MSMEs for the wellness of the economy.