Chaithanya Agasthyaraju is a Chartered Accountant from The Institute of Chartered Accountants of India. With over 20 years of experience, he has honed his expertise in Corporate Finance, Treasury, Financial Planning & Analysis, and Controllership.
The insertion of Clause (h) to Section 43B of Income Tax Act aimed at ensuring timely payments to Micro and small enterprises is a welcome step in addressing the cash crunch faced by Micro and Small enterprises.
While this is a welcome step, the effectiveness of this measure will be limited, if we do not look into making effective, the measures already taken to support MSME. Section 43B refers to allowance of expenditure on payment Basis.
If a buyer makes payment to Micro/Small seller after 45 days but within the Financial Year, then the expenditure may still be allowed as deduction on Payment basis. If it is allowed as deduction for the Buyer, the effectiveness of this measure will be diluted and limited. The Buyer can continue to pay throughout the year to Small/Micro seller as per the existing Credit Terms even after 45 days without any disallowance, except that he has to be mindful of year end purchases not crossing the financial year.
While issues pertaining to the allowance of expenditure if paid after 45 days but within financial year are being discussed and debated, a thought to ponder about would be if MSME can have a negative Working capital cycle?
Most Large OEMs (Original Equipment Manufacturer referring to the manufacturer of the Final Product for Customer) enjoy Negative working capital cycle, implying their money locked up are less than the money they hold; Current assets being lower than Current Liabilities.
How is that the OEMs end up having negative working capital, despite the fact a significant amount of their working capital is locked up in Inventory.
Let us take an Auto OEM which generally holds 3 Months of Import raw material (Should be even higher now due to Geo Political Disruptions), in addition to domestic Raw material and Finished Goods.
Most OEMs, which operate through dealers, especially in Auto industry, get Advance from Dealer or rather say they operate on Cash and Carry. If the dealer has to place an order, payment should be made in Advance to OEM, without which no dispatches are made generally. Hence Trade Receivable which locks up a significant amount of working capital for MSMEs is not a major working capital factor for large OEMs.
While the OEM gets the money in Advance on its sales to dealers, they do not pay in advance or cash and carry with the Vendors. OEMs continue to get Credit Period with its vendors; usually 90 days. Now that’s the Double Bonus for the OEM; Advance from Customers and Deferred payments to Vendors.
While it appears that the section will make significant impact, let us have a closer look at the impact of Sec 43B (h) on the entire supply chain.
Large OEMs, despite having Cash and carry on sales, enjoy a significant Credit period with its vendors (Tier 1 Vendors).
Tier 1 Vendors purchase from Tier 2 and Tier 2 in turn from Tier 3 Vendors. Tier 1 Vendors usually do not fit into the MSME category on account of the large volumes they deal with the OEMs. Tier 2 Vendors generally will be Medium entities while Tier 3 will be small and Micro entities.
Now Since OEMs do not directly deal with Micro and Small entities for its Raw Material supply, Section 43 B ( h) will not have significant impact on the Negative working capital cycle they are already enjoying now. For a manufacturing OEM, some overhead vendors/ Service providers may fit into Micro and Small category, but Raw Material Tier 1 vendors do not generally fit into Micro and Small enterprise category.
While OEM and Tier 1 vendors do not have significant impact, on account of them not directly dealing with Micro and Small entities, Tier 2 vendors and Tier 3 vendors which are medium and small enterprises respectively will have to comply with 43 B (h) and have to make payment to its vendors in 45 days.
Because Tier 2 Vendors have to make payment to its vendors in 45 days, Will OEM agree to revise the payment terms to 45 Days to Tier 1 vendors? And Tier 1 in turn revises the payment terms to 45 days to Tier 2 and Tier 3?
The answer may NOT be an affirmative yes. We have a scenario where Tier 2 MSME Vendor will pay to another Small/micro Tier 3 vendor in 45 days, while it does not get its receivables collected in 45 days. It puts pressure on Tier 2 Vendors who do not have strong balance sheets to get funding from Banks.
An MSME paying to another MSME in 45 days is not what is intended to be achieved with this measure. This is aimed at making, predominantly large organisations pay to Micro and Small entities in 45 days.
The section will have limited impact if the OEMs do not have to bother much about the Vendors who are down in the supply chain.
The amendment to Income Tax Act itself will not be effective in addressing the cash crunch of MSMEs, until we set right the Limitations of the other measures already implemented earlier. One of the most important measures taken was TReDS (Trade Receivable Discounting System), which aimed to bring Buyers, Sellers and Financiers on to the same platform to ease the cash crunch for MSMEs. But TReDS has certain inherent limitations which need to be addressed immediately to make it effective. Listed below are some of the limitations.
There are 4 options available for onboarding TreDs; an entity can choose to onboard any of the 4 authorised platforms. If the Buyer and Seller onboard different Platforms, no discounting can take place. The direction should be aimed at Centralising rather than giving multiple optional platforms. The very idea of bringing all the stake holders on to a single platform is defeated when multiple options exist.
We can even explore the possibility of having Industry wise allocation to each platform - like all the players in Auto Industry onboard platform A, those in FMCG onboard platform B.
To integrate, interface and modify the existing Finance systems with TreDs Platform, significant amount of time and efforts need to be spent. Assuming a case where both Buyer and seller are on boarded on the same platform, either the seller or buyer have to Initiate the Process.
Let us look at a case in which Buyer had to initiate the process.
For the hundreds of suppliers that the Buyer deals with, the buyers’ IT system has to be modified to: To Group the Invoices and create multiple Factoring Units for each of the suppliers, Block for Payment in ERP, the Invoices, after Upload to TreDs. Else the Buyer carries the risk of paying twice, one in normal payment cycle from ERP and second through the TReDS Platform. Change the Status of the Invoices as Paid and Clear the Payable and Payment documents on successful Bidding in TreDs.
If the Factoring Unit is not successfully bid on TreDs platform, based on the reverse feed from the Platform, the Buyer IT system will have to remove, against the invoices, the status “Blocked for Payment" and make it available for payment through ERP in regular payment cycle.
The Finance team will need additional resources to do these uploads to TReDS and ensuring the feeds and reverse feeds get updated.
In case of Seller initiating the process, the Buyer Team will have to validate and confirm the details uploaded to ensure only genuine invoices are uploaded by the seller to get funding.
While some of the TReDS platforms are providing Standard patches to interface with major ERP systems, it still requires significant Investment, not necessarily monetarily but in terms of time ,the organisation’s IT has to spend to modify the Finance Systems and controls.
In case of direct payment to Vendors if there is a delay of, let us say 2 days, it is a normal case of paying after the due date. If the same invoice is bid on TReDS platform by a bank and the payment could not be executed by the Buyer to the bank on due date, it will be reported as SMA violation by the Bank.
Also the Treasury of the Buyer will need to keep track, as you will have dues to Financiers occurring every day based on bidding. These dues are not based on what the Buyer has borrowed from banks but based on what has been Bid on TReDS platform.
While TReDS as a concept helps the seller to get the funds early, what is there in it for the Buyer?
Why should a Buyer end up with all these complications of Investing In IT systems, adding manpower to deal with uploads, interfaces and most importantly risk being reported under SMA every day for Loans which the Buyer has not directly borrowed from any Bank?
That is why you find lot of large corporates onboarded on to one of the TReDS platforms but don’t end up doing any transactions there. Any deal will have to be a win- win for both the parties. We cannot have the Buyer making so many compromises and investments to make the seller (MSME) enjoy the benefits of early payment. Unless we address “what is in it for the Buyer”, TReDS as a concept will fail to deliver what it is envisaged from it.
