Fear and loathing in India’s small factories" (29 January 2020). Specifically, the article said that micro, small and medium enterprises (MSMEs) find it difficult to make goods and services tax (GST) payments within 20 days of raising an invoice when they get payments from their buyers after 90 days, and, even then, only partially. GST payment obligations have made the perennial working capital problem of small enterprises even more acute.
In general, it is not the norm for government revenue to bear the credit risk of taxpayers. It becomes an untenable situation, if the revenue department gets the tax only after the seller gets paid while the buyer claims input tax credit before that. As a perceptive friend put it, it would be a nationalization of credit risk. Of course, the situation is somewhat peculiar to India. Its informal sector is big and the number of MSMEs is very large. Credit availability is a challenge for them in general, working capital availability particularly so, even in the best of times, and especially now in the wake of banks having cut back on lending.
On its part, the government can consider three options. One is a longer window for the payment of GST and for the filing of returns for MSME filers. Another is a reduction in the penal interest rate on late payments by MSMEs for businesses under a certain threshold of revenue. This can be done almost instantly. The third and best option would be to get big buyers to accept invoices linking GST with the Trade Receivables Discounting System (TreDS). That would automatically help MSMEs get paid on time and may even synchronize their receipts with their GST payment cycle. This is not a headline-grabbing reform. It merely carries forward the government’s focus on the TreDS over the years, which has been consistent and laudable. It must keep innovating to make sure that the TreDS is widely used by all big buyers, be they government departments, public enterprises, or private corporations.
There is also the reverse charge mechanism (RCM), which transfers the burden of transmitting GST from sellers onto buyers. The RCM for purchases from unregistered dealers was part of the original design of GST, but was never notified.
In July 2018, the RCM was shifted to category-specific notification, but those too were confined to a very narrow class. Big buyers do not favour the RCM, since it increases their compliance burden, and raises their working capital requirements. If the GST rate relevant to the purchase transaction is 18%, the RCM costs for corporate buyers translates to 18%*r*c, where r is their cost of capital and c is the cost of the purchase. Though this initial cost can be fully recovered as an input tax credit, it does raise the working capital requirements of corporate buyers, which could make them switch away from RCM-based MSME suppliers.
This threat, however, could be more symbolic than substantive. One, buyers rely on a particular supplier because they are happy with the quality and/or price. They may not shift because of RCM once the GST system settles down, as is happening now. Their earlier fears on the compliance burden may no longer be as salient, with the system running much better. Critics must take note. At 18% GST and a cost of capital of, say, 20% per annum, an MSME not asking for RCM from the buyer would bear a cost of 18%*20%=3.6% or 3.6/12= 0.30% per month. On the other hand, if the big corporate buyer faces a lower cost of working capital finances, as is likely to be the case, it might be a win-win situation to do RCM. Instead of the seller incurring a carrying cost at 18%*20% per annum, it might be beneficial to all for the buyer to bear 18%*10% per annum. Further, the seller can pass on some of the savings realised from having been spared the GST payment to the buyer. After all, it is reasonable to assume that suppliers would be including their working capital cost in the price of the product or service. This could happen through an optional RCM mechanism.
Some not-so-big buyers may even welcome such an option because when they deal with new and unfamiliar suppliers, they run the risk of not actually getting the benefit of the GST they pay to the supplier. The benefit of RCM for such buyers is that they do not have to worry about losing out on the input credit. They can agree with the MSME supplier to remit the GST into the supplier’s GST ledger directly instead of paying that amount to the seller. This would happen without mandatory classification/ stigmatization as RCM. It would be an optional method of transaction. Options would be chosen through mutual consent and price discounts agreed upon.
There may be other solutions. However, if the country is serious about achieving its $5 trillion gross domestic product goal, it must make doing business easy for MSMEs. Easing pressures on their working capital funding—without compromising the interests and rights of government revenue—is a key aspect of the ease of doing business for MSMEs.
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