The 45-day deadline: How the new rule will affect MSMEs’ financial operations

While we are well on our way to becoming the third-largest economy in the world, the role played by the Micro Small, and Medium enterprise (MSME) sector in the same is well recognised. The sector boasts of over 63 million enterprises, which contribute nearly 30% to the GDP. The MSME sector generates around 45% of total manufacturing and 40% of total exports. Being primarily labour-oriented, the sector employs over 113 million people. 

However, the sector is traditionally beset with challenging financial conditions arising out of inadequate availability of funds and delayed realisation of dues from its buyers. Over the years, several steps have been taken to support the sector. In this article, we will discuss the latest amendments of the Finance Bill 2023 that will bring changes in the rules relating to payment of dues of MSMEs, which are to be effective from April 1, 2024.

Current mechanism

The MSME sector provides a wide range of products and services to both large corporates and other entities as a part of the vast supply chain. The goods and services are by way of intermediary products for other industries/companies or by way of final products for the ultimate consumers. In both cases, the conditions of the duration of the payment vary depending on the nature of the industry and the nature of the end product. 

The financial operations of the MSMEs are directly dependent on the normal credit period and the actual realisation period of dues. The MSME sector invariably faces a phenomenon of late payments from its large corporate clients and other buyers because of the intense competition and weak negotiating powers. The large buyers on the other hand enjoy bigger financial clout and can delay the payments due to the MSME suppliers. This leads to a perpetual strained financial position for most of the MSME entities.

Government initiatives for the MSME sector

Recognising the significant and crucial role played by the MSMEs, the government has been taking proactive steps to support this sector. In July 2020, the definition of MSME was revised to widen the scope and ambit of classification into various subcategories based on the turnover of the unit and investment in plant and machinery. Such units now have significant amount of receivable dues from large buyers, but no change has been brought with respect to the rules relating to the same in 2020 and Section 15 of the MSME Act 2006 continued to be applicable. 

As per this Act, MSMEs are required to be paid by the business enterprises (buyers) within 45 days depending on the presence of a written agreement. In the absence of a written agreement, payment needs to be made within 15 days. In case there is a written agreement, payment shall be made as per the agreed-upon timelines not exceeding 45 days. Compound interest is payable in case of delays beyond 45 days. 

In 2017 the Ministry of MSME launched a portal called MSME Samadhan relating to delayed payments, to empower these units to facilitate timely payments

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Legal support to help MSMEs tackle challenges

New rules applicable from April 1, 2024

Despite the proactive approach and frequent steps taken by the government, to enable timely payments to the MSME sector, the problem of delay in payments has persisted, leading to a perpetual financially stained working capital position and operational challenges for MSMEs. Hence, there was a need to bring in new rules to create a more robust mechanism for encouraging timely payments to MSMEs by their customers.

Under the Finance Act 2023, a new section 43 B (h) has been inserted in the MSME Act of 2006, which stipulates that any amount payable to any MSME for goods supplied or services provided may be deducted in the same year if it is paid within the deadline stipulated under the Act (45 days as elaborated above). This implies that the buyers must pay any pending bills within 45 days, failing which higher tax will have to be paid. To avail of the tax benefits, the large buyers are thus being nudged and prompted to make timely payments. This will enable faster cash flows to the MSME, thereby improving their financial operating cycle. 

Timely realisation of receivables shall also reduce their dependence on loans which will reduce the interest cost thereby improving their overall profitability. This is also expected to improve the negotiation power of the MSME sector as a whole. 

Further, to improve the overall business ecosystem and tax efficiency it will be also in the interest of the large buyers to make timely payments and avail of the tax benefits.

Conclusion

The new guidelines relating to the 45-day deadline for payment of dues to MSME is a major step to boost the health of the sector by encouraging timely payments. The success of the mechanism shall however depend on efficient implementation and active involvement of all the stakeholders.

(Jyoti Prakash Gadia is the Managing Director at Resurgent India)