The Chartered Accountant • Journal of ICAI April 2021 • Vol. 69 • No. 10 • pp. 42–47 (Journal pp. 1214–1219)
MSME

Creating Conducive Direct Tax Environment for MSMEs

CA. Rajendra Agiwal*, CA. Rayan Doshi* & Saurabh Kulkarni# *The authors are members of the Institute. #The author is subject expert. They can be reached at rajendraagiwal@gmail.com and eboard@icai.in.

“India has an entire legislature dedicated to small businesses, known as Micro, Small and Medium Enterprises (MSMEs). The journey of MSMEs at this stage was difficult, since, in the past India’s economy was driven largely through the agriculture and allied sector. Soon came focus on industrial development and now the service sector contributes over 54 per cent of the economy and almost four-fifths of total FDI inflows. At the same time, MSMEs have played a vital role in the Indian economy, significantly to about 24.5% of the country’s gross domestic product (GDP). An integral part of the supply chain, the produce of MSMEs contributes to about 45%1 of the overall exports. Read on....”

MSMEs employ a large number of people across the country and play their part as a significant rural employer, as majority of the MSMEs operate in rural India. To mitigate the problem of unemployment is again a challenging task and obviously growth of MSMEs may be the answer to a large extent. As per the MSME Development Act, 2006 (MSMED), the MSME industry has two sectors: the manufacturing sector and the service sector. In India, the manufacturing end of the industry comprises of at least 6% of the GDP and the service end contributes to almost 25% of the GDP.

Existing Safeguards for MSME’s

MSME’s being the thread that runs throughout the economy is granted additional safeguards by the government specifically relating to the recovery of their sales/ services. The MSMED Act, 2006, has put in place various reporting obligations and safeguards for the MSME sector. The MSMED Act overlaps with the Income-tax Act, 1961 and requires a host of reporting and compliance requirements. Key compliances for the MSME sector in the Income-tax Act have been captured below:

Interest Inadmissible under Section 23 of MSMED Act, 2006

The first and foremost enactment piece of legislature which came to notice is separate clause introduced in the tax audit report somewhere in 2009 and applicable to all the assesses, the tax auditor is required to report the amount of interest inadmissible under section 23 of the MSMED Act, 2006. As per the said section, any interest for delayed payment to MSME is not allowed as deductible expenditure while computing the total income of the assessee under the Income-tax Act, 1961 notwithstanding the provisions of section 36(1)(iii) of Income-tax Act, 1961.

The intention of inserting such provision is quite obvious, i.e., MSMEs are running their business with limited funds & working capital. Hence, the outstanding dues of MSMEs should be cleared within the stipulated time, so that MSMEs are in a position to run their business smoothly without any financial hurdle. The survey of judicial precedents do not throw any case law on the issue so by and large it can be presumed that the object of inserting this clause is served. Though there could be cases of disclaimer about reporting obligation as required information at the end of the auditee is not provided to the auditor so as to enable him to qualify his report.

“Any interest for delayed payment to MSME is not allowed as deductible expenditure while computing the total income of the assessee under the Income-tax Act, 1961 notwithstanding the provisions of section 36(1)(iii) of Income-tax Act, 1961.”

Section 15 of MSMED Act, 2006

Requirement on the buyer to make payment on or before the date agreed upon in writing, or where there is no agreement in this behalf, before the appointed day. This section also provides that the period agreed upon in writing shall not exceed 45 days from the day of acceptance or the day of deemed acceptance.

Section 16 of MSMED Act, 2006

Section 16 of the MSME Act provides for the date from which and the rate at which the interest is payable. Accordingly, where a buyer fails to make payment of the amount to the supplier, as required under section 15, the buyer shall, be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed date or, as the case may be, from the date immediately following the date agreed upon, at 3 times of the bank rate notified by the Reserve Bank of India (RBI).

Section 22 of MSMED Act, 2006

This section provides that where any buyer is required to get his annual accounts audited under section 44AB of Income-tax Act, 1961 or under any law, such buyer shall furnish the following additional information in his annual statement of accounts, namely:

  • The principal amount and interest due thereon (to be shown separately) remaining unpaid.
  • The amount of interest paid by the buyer in terms of Section 16 along with the amount of payment made to supplier beyond the appointed date during each accounting year.
  • The amount of interest due and payable for the delay in making payment (which have been paid but beyond the appointed day during the year) but without adding the interest specified under this Act.
  • The amount of interest accrued and remaining unpaid at the end of each accounting year.
  • The amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues as above are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/s 23.

Challenges Faced by MSMEs

MSMEs face a number of challenges that relate to absence of adequate and timely banking finance, procurement of raw materials at a competitive rates, need for better Infrastructure facilities, lack of skilled manpower, etc.

To overcome these concerns, there are a number of initiatives taken by the Government to create skilled manpower, overcoming the challenges.

For example, if the MSME is backed-up with adequate finance, competitive wages/ salary can be offered to it’s manpower, where raw material is available at competitive rates, the MSME will be in a position to break-even early, thereby earning profits which will enable compensation to the manpower. Likewise, if the MSME is equipped with basic infrastructure facilities, the manpower would be willing to work for such MSMEs.

Fortunately, Income-tax Act, 1961 in the avatar of section 2(15) which defines “Charitable Purpose” includes one of the purposes as “Education”. Under this piece of legislation if NGOs/ Trusts are formed to impart education under the wider connotation of education as charitable purpose, it will enhance availability of skilled manpower. However, multiple amendments have resulted in added complexities in the trust taxation regime. Professional fraternity should step-up on trust taxation compliance to avoid any consequences. This will help the MSME sector with required skilled employment.

Vaccine for the MSMEs

As the world is currently reeling from the wrath of the ongoing Coronavirus pandemic, several small businesses have even been forced to shut down their operations completely or go neck-deep in debt in order to try and survive this tough period. The Government of India in order to support the rehabilitation and ensure the upliftment has implemented major economic stimulus with a special focus on MSMEs to better equip them in the current situation. The registration criteria has also been modified so that a large number of enterprises are able to take benefits of the facilities available to the MSMEs and help in Indian growth story by virtue of their registration as an MSME/ SSI (‘Small Scale Industries’) under the MSMED Act, these entities are entitled to certain benefits. Some of the benefits are:

  1. Collateral Free Bank Loans: The Government of India has recently notified that collateral-free credit shall be available to all companies in all small and micro business sectors. This initiative ensures funds for MSMEs/SSIs. Under this initiative, existing as well as the new enterprises can claim the benefits enshrined herein. A trust by the name of the Credit Guarantee Trust Fund Scheme was introduced by the Government of India, Small Industries Development Bank of India (‘SIDBI’) and the Ministry of Micro, Small and Medium Enterprise Development to ensure this scheme is implemented for all MSMEs/SSIs.
  2. Patent Registration: A significant subsidy of 50% is given to registered MSMEs/SSIs. This subsidy can be availed for patent registration only by furnishing a copy of the application to the respective ministry.
  3. Exemption of Interest Rates on Overdrafts: Registered MSMEs/SSIs are eligible to avail a benefit of 1% on overdrafts however the implementation of this scheme differs from bank to bank and clarity needs to be sought from the bank extending the overdraft facility.
  4. Eligibility for Industrial Promotion Subsidy: The Government of India also ensures that registered MSMEs/SSIs are eligible for subsidies on amounts spent towards Industrial Promotion. The Micro, Small and Medium Enterprises Ministry regulates the quantum of the subsidy and the same is a regular feature in the budget as well.
  5. Protection against delayed payments: Very often buyers of services or products from MSMEs/SSIs usually tend to delay/default on the payments to be made to them. The Ministry of Micro, Small and Medium Enterprise, Government of India with the intention of providing support to these enterprises enshrined upon them the right to charge interest on the payments that are delayed from their buyers/customers. For the quick and easy settlement of such disputes, the government has issued guidelines advising such settlement must be done in minimum time through conciliation and arbitration and other such measures. In case, if any MSME/SSI registered enterprise supplies/provides any goods/services to a buyer/customer then the buyer/customer is required to make the complete payment on or before the agreed date of payment as per the arrangement between the parties or within 15 days from the day they had accepted the goods/services from MSME/SSI registered business in cases where the date of payment is not mentioned. If the buyer/customer causes a delay in the payment for more than 45 days after accepting/consuming the products or services then the buyer/customer is liable to be charged compound interest on the amount that was agreed to be paid for the products/services provided/rendered. The interest rate is usually three times the rate that is notified by the RBI.
  6. Concession on electricity bills: This fixed rate of concession is available to all registered MSMEs/SSIs by simply furnishing an application to the Electricity Department or their respective DISCOM, such application shall be accompanied with a copy of the MSME/SSI registration obtained under the MSMED Act. Granting concessions is of course a welcome move, but uninterrupted availability of power supply is of utmost importance. If productivity is hampered due to lack of power supply, MSMEs may not be in a position to sustain such losses in long term. On the power sector, Government has encouraged through providing tax holiday to power sector companies (especially windmill) under section 80IA of the Income-tax Act, 1961 along with accelerated depreciation. Increase in windmill farms as well as other green energy parks, will increase the supply of power. Consequently, will help in providing uninterrupted power supply to MSMEs. So it can be considered as integrated step though there is no evidence to demonstrate that it is for MSMEs.
  7. Reimbursement of ISO Certification charges: Any amount spent towards obtaining an ISO certification by registered MSMEs/SSIs is eligible for reimbursement from the Government of India on filing of an application to that effect along with the requisite set of documentation.
  8. No global tenders up to INR 200 crores: The government has amended the General Financial Rules 20172 to disallow global tenders in government procurement up to INR 200 crore, as announced in the Aatmanirbhar Bharat package. This bold step is expected to create more opportunities for domestic players and will allow the local industry to gain from this initiative.

Recently, the World Bank has allocated about INR 5,600 crore (USD 750 million) emergency response funding to the MSME sector. This provides much-needed liquidity and supports the government’s strategy of using NBFCs and small banks to channelize funds to the MSMEs.

Biting the Silver Bullet

The government has realized the potential of the MSME sector and at the same time understands the perils plaguing the economy due to its under-performance. While some initiatives have been taken on the policy front, the impact of the taxation system on MSME is twin layered- through the corporate tax and GST. The budget of 2020 had a major focus on accelerating the growth of the MSMEs. As a structural change was made in the definition of an MSME, thereby enhancing the base, more enterprises are now poised to avail tax benefits announced to MSMEs. Some ways in which the current taxation system is expected to boost MSMEs are:

  • Reduction of corporate tax rate: The corporate tax rate for new manufacturing companies has been reduced to 15% while the overall tax rate for all other companies has been cut down to 22%. While the reduction in tax rates puts India in the league of countries having one of the lowest tax rates, the budget has done away with some of the incentives available and utilised by the MSME industry namely, tax holidays for infrastructure, agriculture, and food processing units. While this is a welcome move, government should consider similar rate cuts for business which are in the form of partnership or proprietorship, since there are many MSMEs in this category. Though this move needs applause, at the same time, one should be conscious that certainly it is challenging task before the Government to raise revenue as well to run the economy.
  • Relief from tax audit: In a bid to make tax compliances simpler for a wider number of MSMEs and thereby allowing them to focus on growth, the threshold provided for entities to get their books audited under the income-tax has been increased from the existing limit of INR 1 crore to INR 5 crore (with some conditions). The increase in threshold surely relieves MSMEs which are able to satisfy the prescribed conditions from the compliance burden.
  • Goods and Service Tax: Several changes have been made in the indirect tax system to improve compliance. Simplification of GST returns, Aadhaar-based verification of taxpayers, electronic invoicing to facilitate compliance, etc. have made GST compliance multifold easier for MSMEs.
  • Tax holiday expansion for start-ups: Startups in the MSME sector have not enjoyed the high-ticket funding or unending queues of angel investors filling up gaps caused by cash burnouts. To allow fledgling startups an opportunity to grow, startups having turnover up to INR 25 crores earlier had the tax benefit of getting 100 per cent of profits as a deduction for three consecutive years. In a further bid to support startups, this limit has gone up to INR 100 crore. Additionally, the benefit has been extended to be allowed for three out of the first 10 years instead of the first seven years. Relieving startups from the burden of taxation has provided this ultra-competitive sector with breathing space.

“Government’s constant focus on developing infrastructure, such as power, roads, waterways, etc. are steps in the right direction. Such efforts from the Government keeps the MSME sector hopeful of better ways of doing business.”

MSME Wishlist

  • Expansion of TDS/TCS: The current Budget, 2021 had expanded the scope of TDS provisions widely, specifically the goods transactions are now proposed to be in the ambit of TDS net. Although the intention of widening the TDS scope is not of much concern, but the MSMEs will need to cope-up with the compliance requirement. Apart from the compliance burden, if the buyer satisfies the conditions prescribed under such TDS provisions, the cash inflow from the buyer will be reduced by the tax deducted amount.
  • Faceless assessment/appeal regime and inability to scale technologically: Lot of new initiatives are brought into the income tax net and all these initiatives are digitally driven. Given that most of the assessments are now conducted in a faceless mechanism, MSMEs will need to invest in digital infrastructure.
  • Lack of good tax advisor: Typically, it is seen that small business struggle to get good tax advice and in turn may end up in an unavoidable situation. The MSME owners are largely occupied in their business activities and hence, a good tax advisor would be of a great help. The chartered accountants with their strong skills in the area of taxation can play a crucial role in correctly advising MSMEs on tax matters.
  • MSME corridor: Given the challenges faced by this upcoming sector, Government may consider allocating dedicated space for MSME entities. Wherein all the basic infrastructure facilities are made available to this sector. Such initiative may provide a larger field of play to the MSME sector.

“The government has realized the potential of the MSME sector and at the same time understands the perils plaguing the economy due to its under-performance.”

MSMEs may be incorporated in several different legal entity types. From sole proprietorships and One Person Companies to Limited Liability Partnerships and Private/ Public Limited Companies, the choice of the business entity is dependent on various factors such as owner liability, compliance burden, investment and funding, exit strategy, taxation, etc. As most of the MSMEs are formed as a proprietorship or partnership enterprise, it is imperative for the sector to strive towards corporatization of Small & Medium Enterprises for good corporate governance as well as to energize the economy as a whole.

Along with choice of form of entity the corresponding provisions under Income-tax Act shall be applicable. For example, compliance of tax deductions at source are mainly applicable to an entity other than individual and HUF unless the individual and HUF are audited in preceding year u/s 44AB, different tax rates, eligible deductions for specific form of entity, etc. However, the choice of form of entity may not be driven by simply looking at direct tax provisions and a host of other considerations would play a role in exercising choice of form of entity.

At last there is no other way to conclude the thought but saying that one has to step boldly. Refinement/ Revision/ Improvement is a process and as an accountants’ we know that either there could be profit/ loss/ breakeven, but the show must go on.

— CA. Rajendra Agiwal, CA. Rayan Doshi & Saurabh Kulkarni