Micro, small and medium enterprises, or MSMEs, are the engines of growth for the developing economies of the world. In India, MSMEs contribute 45 percent of industrial output and 40 percent of export and employ nearly 42 million people, second only to the agriculture sector.
There are around 35 million SMEs across the country. I foresee working capital management to be a greater issue for MSMEs in the coming months, as public banks (with greater than 80% market share) are reeling under the pressure of bad loans, and they will be more reluctant to give credit.
Goods and Services Tax (GST) promises to enable a “One nation, One Tax” regime, and carries the flagship of ease of doing business in India. While it is yet to be seen how this colossal tax reform will reshape the Indian economy, it will certainly require a major overhaul in the business and operating models of the MSMEs. While on one hand, GST will enable turnover growth for companies by easing inter-state sales, on the other hand, it will materially reduce the tax margin arbitrage that is currently prevalent in the MSME space.
Under the GST regime, in a running business, the combined effect of monthly tax payments, receivables on account of a longer trade credit cycle, and possible delays in getting Input Tax Credit could see funds getting blocked.
With businesses being required to remit taxes under GST every month (from a quarterly frequency earlier), cash liquidity could tighten, as on one hand, companies will need to remit taxes collected on the previous month’s sales, while on the other hand, their debtors will continue to pay them on the same payment terms (for example 90 days). Hence, the working capital gap is likely to go up.
Since outward and inward supplies would be electronically matched every month, availing of input tax credit by the buyer would be based on the compliances of the supplier. Any failure by the supplier to declare his outward supplies correctly would lead to mismatch of returns, leading to reversal of credits availed by the MSMEs. These types of matching issues will result in an increase in working capital gap. Input Tax Credit could also be delayed if a supplier has not remitted taxes on their sales in time.
The GST-framework will increase tax compliance levels substantially because non-compliant businesses will be at a severe disadvantage. When a buyer purchases a good/service from a non-compliant firm, the buyer will not receive the Input Tax Credit on their purchase. Thus, in effect, the buyer will have to pay the seller’s tax liability. This will discourage companies from doing business with non-compliant or unregistered firms. Hence, my recommendation to all MSMEs, including those in the tax-exempt turnover bracket of Rs 20 lakh, would be to register themselves under GST. While companies under Rs 20-lakh turnover are not required to pay GST, non-registration will make it difficult for their customers to claim appropriate Tax Credit.
Finally, the entire economy will depend on the smooth functioning of GST-Network (GSTN), the IT backbone where millions of invoices will be uploaded monthly. While there may be short-term pain, and teething issues in transitioning to the new regime, I believe that GST will herald an era of greater transparency, compliance, and eventually digital data availability that will enable the Indian economy to grow faster. Greater access to data and a measurable working capital gap will enable newer and more cost-effective forms of short-term financing which will ultimately help companies grow their businesses faster.
(Author is Head – SME Business, Magma Fincrop Limited)