A new law derecognising as an expense any payment companies owe to registered micro, small or medium enterprises beyond 45 days of receiving goods or services will push them to make prompt payments. But it falls short of a definitive solution to the problem of delayed payments to vendors.
If a claimed expense is not recognised by tax authorities, it would remain a part of a company’s income and earnings. In effect, the company would have to pay income tax on delayed payments to vendors. This could well persuade many companies to stop making vendors wait long for payments on goods and services supplied.
When a company delays payments, it, in effect, enjoys free credit to the extent of the amount due and for the period of the delay. The cost of credit is borne by the supplier, who, typically, as an MSME would have a higher cost of credit.
Past attempts to persuade prompt payments to MSMEs have not been effective.
The mandate to make payments within 45 days was the first legal intervention. Then, the government mandated corporate buyers and their suppliers to register on the electronic factoring platform, TReDS (Trade Receivables electronic Discounting System).
In factoring, a financial intermediary takes over the receivables for an invoice raised by a supplier on a large buyer of supplies, and gives cash upfront to the supplier, after applying a discount.
The crucial difference between factoring and bill discounting is in the nature of the credit relationship created in either case.
In bill discounting, the credit relationship established by the act of discounting the bills raised by a supplier is between the financial entity that gives money to the supplier, after levying a discount on the face value of the bills raised, and the suppliers. It is the job of the suppliers to collect their dues and pay off the lender. The cost of credit would be according to the risk profile of the suppliers.
In factoring, the financier buys up from the suppliers their dues from the buyer of the supplies, on whom the original invoice has been raised. The credit relationship is between the financier and the company that had bought supplies from small producers.
While upfront cash is paid to the suppliers for the receivables against the invoices raised on the buyer of supplies, the obligation to clear the debt incurred for clearing the dues of the suppliers falls on the buyer of the supplies. Here, the cost of the credit entailed reflects the superior credit rating of the buyer of the supplies, in comparison with the rating of the small suppliers.
The mandated obligation to subject themselves to factoring via the TReDS platform met with quiet defiance. Then, in 2023, the government passed a law to not recognise expenses arising from vendor payments delayed by more than 45 days. It is slated to kick in when companies file their tax returns for the current financial year, ending 31 March.
Small industry representatives point out that the biggest culprits in payment delays are departments of the governments at the Centre, the state, and municipal and panchayat levels, including the Railways, defence, the Public Works Department, and electricity agencies. These do not have to file income tax returns and are not affected by their expenses on procurement from MSMEs not being recognised as expenses.
Public sector enterprises, however, would be affected by the law.
But determined defenders of free credit availed of at the expense of MSME suppliers could devise workarounds to blunt the bite of the law. While goods might be supplied, unless its acceptance is acknowledged by the recipient, the 45-day payment window would not commence.
A just-in-time delivery benefits the typical manufacturing company because it reduces the cost of holding inventory. Suppose the cost of holding inventory is, in any case, eliminated by the simple expedient of forcing the supplier to bear the cost, piled-up inputs present no problem for the buyer of the inputs, even if these add to the cost of the supplier.
A superior solution might be to incorporate promptness of payment to suppliers in credit rating. If a credit rating agency knocks off points to penalise a company for delayed payments to suppliers, it would affect the company’s attempt to get the high credit rating it needs to qualify for a loan.
