Sometimes, well-intentioned policies can have unintended consequences. Such is the case with the 45-day payment rule for MSMEs. As preparations for the Union Budget 2024-25 get underway, finance ministry officials are evaluating the impact of the new Income Tax Act provision that mandates payments to micro, small, and medium enterprises (MSMEs) within 45 days. Sources indicate that some relief may be forthcoming to ensure payments aren’t strictly tied to this window.

During an interaction with MSMEs in Ludhiana on May 29, Finance Minister Nirmala Sitharaman indicated that the Centre is open to reconsidering the 45-day payment rule if MSMEs find it burdensome.

The root of the issue lies in the Finance Act 2023, which added a new clause (h) in section 43B of the Income Tax Act. This clause requires larger enterprises to pay MSMEs within 45 days of a written agreement. Failure to do so disallows these larger businesses from deducting the expense from their taxable income, potentially resulting in higher taxes. This stringent timeline has led many small business owners to cancel their MSME registrations, raising questions about whether this policy truly supports the sector or inadvertently benefits larger enterprises.

Implemented on April 1, 2024, the provision aims to ensure timely payments to small businesses, who often face long delays from buyers, affecting their working capital. A 2022 report by the Global Alliance for Mass Entrepreneurship (GAME) estimated that delayed payments to MSMEs amounted to nearly ₹10.7 lakh crore, with 80% due to micro and small enterprises.

However, many in the industry were unaware of the clause, causing uproar as MSMEs feared losing customers. Several industry associations have requested either deferment of the provision or an extension of the 45-day period. While the Ministry of Micro, Small & Medium Enterprises has sought to understand the issue, it’s ultimately the finance ministry’s responsibility to address it.

In early May, the Supreme Court’s decision to reject the Federation of All India Vyapar Mandal’s (FAIVM) petition against the 45-day rule sent shockwaves through the sector. This ruling heightened stress levels among MSMEs and triggered a wave of order cancellations from large enterprises, casting doubt on the future of many small businesses.

Since then, FAIVM and other industry associations have been in talks with the government to resolve the issue. “This provision has caused massive problems for small firms and infringes on the fundamental right to do business,” says FAIVM President, suggesting an extension of the period to 180 days. A FAIVM delegation also met the Finance Minister, seeking reconsideration of both the timeline and tax implications.

The Fallout

The Co-founder & Director of Technosys Integrated Solutions, a Bhopal-based firm providing smart city and intelligent traffic management solutions, noted that his firm withdrew orders from MSMEs after the rule came into effect, deeming the new business environment impractical. “Previously, we subcontracted to micro-level players, helping local communities grow,” he explained. “But now, that business model isn’t feasible. In the service industry, extensive back-and-forth is required.”

He cited a recent project in Ayodhya involving AI-based cameras and traffic management. “After completing the work, MSMEs expect payment within 45 days,” he said, but quality checks and government payment delays complicate timely payments to MSMEs. Consequently, he now subcontracts to larger businesses.

Many small businesses face similar issues. Some have relinquished their MSME registration, while others have reduced production or shifted to a five-day week. The National Chairman of the Association of Indian Entrepreneurs (AIE) reported a decline in MSME registrations due to the cancellation of orders. “The damage was done as it came into effect in the last quarter of the fiscal year,” he said, warning that the provision will impact the last quarter of the current fiscal as well. He suggested that any relaxation of the period to 120 days would not help MSMEs and called for the withdrawal of the directive and a suitable alternative strategy.