MSMEs rhetoric, rules and reality

On 27 June, marked as National MSME Day, a wave of lavish tributes canonised small businesses as the ‘backbone’ of employment, industrial production and exports. On 1 July, the nation marked GST Day, commemorating the ninth anniversary of its rollout.

Yet the sobering reality is that India’s small entrepreneurs still do not see a viable pathway to formalisation, trapped in a policy-induced pincer movement, where large corporate customers weaponise time and a rigid, accrual-based tax architecture weaponises compliance.

This structural contradiction has created a devastating double whammy for MSMEs. On one side, small units are forced to act as interest-free credit lines for big corporate buyers and public sector undertakings (PSUs) who delay payments for months. On the other side, the GST demands immediate, non-negotiable tax payments on money that the MSME has not yet received. This can choke small businesses to death.

Under Section 15 of the MSMED Act, 2006, buyers are legally obliged to settle vendor bills within 45 days if there is a written contract, or 15 days in its absence. The statute also mandates a hefty penalty and a compound interest liability.

Yet these timelines are unreal. Large private entities and government bodies routinely stretch payment cycles to 90/120/180 days.

Institutional interventions to reduce this gap have crashed into corporate non-cooperation. Take the Trade Receivables Discounting System (TReDS). This RBI-regulated electronic platform is meant to let MSMEs auction invoices to banks for instant liquidity. It is called bill discounting on an electronic platform.

But large corporates and central public sector enterprises refuse to onboard or approve invoices. Because TReDS binds buyers to an inflexible auto-debit system on maturity, any failure auto-reports them to credit bureaus. Rather than clean up their cash management to protect their credit scores, corporate giants simply block the platform entirely, leaving vendors out in the cold.

This chronic payment delay is made worse by the GST framework, which operates on the basis of accruals rather than cash flows. If an invoice is generated, the tax must be paid by the 20th of the next month, irrespective of when the payment is received. So, the MSME must pay 18 per cent soon after raising an invoice, but the corporate buyer can ignore the 45-day limit without paying a rupee.

This creates a terrible cash-flow inversion. Small vendors are forced to default on employee payrolls or secure high-interest market loans. Compounding this cash crunch is the reality of low digital literacy, lack of access to modern tech and complex portal architectures. In semi-urban industrial clusters, the problem is further exacerbated by internet connectivity problems.

NSSO (National Sample Survey Office) data from its Annual Survey of Unincorporated Sector Enterprises (ASUSE) reveals that India has an estimated 77 million non-agricultural, non-construction unincorporated establishments. Yet, according to available data, these enterprises are avoiding the State’s formal mechanisms because systems are hostile. Just about one million micro-enterprises are registered under GST.

Furthermore, while GSTN records indicate that roughly seven million taxpayers report an annual topline below Rs 1 crore, the ground-level survey by ASUSE finds fewer than 1.2 million such GST-registered establishments. This massive shortfall is not a sign of widespread tax evasion but a desperate survival strategy. Small businesses realise that stepping into the GST system may lead to suffocation.

This double whammy means a profound existential paradox. Rather than face cash outlays for unpaid invoices, most small businesses choose to stay outside the GST ambit. But non-registration is commercial exile. Large corporate supply chains are built around maximising input tax credit. If an MSME is not registered under GST, big corporates won’t do business with them.

For those who do register to survive, the legal remedies are rendered useless by power asymmetries. Policymakers point to the MSME Samadhaan portal to ‘name and shame’ errant buyers, but this betrays a lack of understanding of the supply chain.

Most specialised MSMEs rely on a single, big corporate customer — going up to 80–100 per cent of their revenue. An MSME vendor cannot ‘name and shame’ its customer because that customer is too important to antagonise. To aggressively demand the 45-day rule, enforce Section 43B(h) of the Income Tax Act, or file a Samadhaan case is to invite immediate, quiet de-panelment. The corporate buyer will simply move to a different vendor.

Even the 180-day input tax credit reversal rule under GST exposes the State’s self-interest. If a buyer defaults for 180 days, the law forces them to return the claimed tax credit to the government with an 18 per cent interest penalty. The State successfully collects its penalty from the large corporate, but the suffering MSME receives no tax refund and no capital relief. The government secures its revenue twice over, while the small business is left holding a toxic bad debt.

To align the tax law with real-life conditions, the state must consider three structural interventions:

1. Cash-based GST for micro-enterprises. Businesses up to a specific turnover threshold must be allowed to deposit GST only when the invoice amount reaches their bank account. Tax collection should trace actual capital, not paper invoices

2. Low-bandwidth portal architecture. Introduce a radically simplified, lightweight version of the tax portal optimised for micro-enterprises. It must function seamlessly even where internet connectivity is poor and cut the monthly filing burden down to bare minimum

3. GSTN-TReDS digital bridge. Large corporate buyers must not have veto power over invoice approval. The moment an e-invoice involving a large corporate (above the Rs 250 cr. threshold) is generated on the GST portal, the system must automatically create an unalterable, pre-approved trade receivable on TReDS. This will allow banks to instantly fund the vendor and cut the uncooperative buyer out of the financing loop

MSMEs can truly be the backbone of the economy, but they must be offered a realistic pathway to formalisation.

Ajit Ranade is a noted economist. More of his writing here

Article courtesy: The Billion Press