India’s Small-Firm Credit Problem Is Hidden in Buyers’ Tax Returns

An invoice can be an instrument of credit even when nobody calls it a loan. A small Indian manufacturer delivers components, pays wages and meets its electricity bill. Its customer accepts the goods but takes months to pay. The manufacturer has effectively financed the customer’s working capital, often while borrowing at a higher interest rate itself. The transaction looks like ordinary trade. Economically, it can be a transfer from the weaker balance-sheet to the stronger one.

India’s attempt to change this arrangement deserves more attention than it receives. Section 43B(h) of the Income-tax Act, introduced through the Finance Act of 2023 and applicable from assessment year 2024-25, links a buyer’s tax deduction to timely payment for purchases from micro and small enterprises. It is a consequential experiment: using the purchaser’s tax return to enforce the supplier’s right to be paid.

The objective is sound. The outcome is less automatic. A rule that makes delayed payment expensive can encourage prompt settlement. It can also encourage buyers to change suppliers. The distinction matters for jobs, investment and the organisation of Indian industry.

The loan hidden inside a purchase

Small-business finance is usually discussed through bank lending: collateral requirements, credit guarantees, interest rates and the reach of formal lenders. These matter. But they capture only one side of a firm’s financing needs. The other is how quickly money returns after a sale.

Consider a supplier with monthly sales of ₹20 lakh. If its collection period falls from 90 days to 45 days, roughly ₹30 lakh can be released from receivables, assuming steady sales and no other changes. That is not additional profit. It is capital previously trapped in customers’ accounts becoming available to pay workers, reduce borrowing or purchase materials.

Late payment is especially costly where the supplier cannot delay its own obligations. Wages and power bills arrive on schedule. GST liabilities can also arise before the customer pays. A profitable business can therefore run short of cash without having mismanaged production or priced its goods badly.

This is why payment discipline belongs in the productivity debate. A machine purchased with a subsidised loan does little good if the owner cannot finance the next production cycle. Nor does a larger order necessarily help: when collection is slow, growth can deepen a cash shortage.

What the tax rule changes

The Micro, Small and Medium Enterprises Development Act, 2006 already sets payment deadlines for covered purchases. Where there is a written agreement, the agreed period cannot exceed 45 days from acceptance or deemed acceptance. Without such an agreement, the statutory framework generally requires payment within 15 days. The law also provides for interest on delayed payments and a dispute-resolution mechanism.

Section 43B(h) adds a different lever. For an otherwise deductible sum payable to a covered micro or small enterprise beyond the statutory deadline, the deduction is generally available only in the year of actual payment. Medium enterprises are outside this particular provision. Unlike several other items under section 43B, the ordinary concession allowing payment by the income-tax return filing deadline does not apply here.

The practical pressure is strongest when an overdue bill remains unpaid across the financial-year boundary. A purchaser may face higher taxable income for that year, with the deduction shifting to the year in which payment occurs. This is principally a timing consequence, not necessarily a permanent loss of the deduction. Its financing cost nevertheless gives tax-paying buyers a reason to monitor invoices more closely.

That design has an advantage over relying entirely on suppliers to sue. A small firm may be reluctant to pursue a customer on whom its order book depends. A tax rule brings accountants, auditors and finance departments into the payment process without requiring the supplier to begin every confrontation.

The risk is displacement, not just delay

Yet procurement departments have choices that tax legislation cannot ignore. They can pay a small supplier sooner. They can negotiate lower prices to compensate for shorter credit. Or they can purchase from a larger enterprise to which this particular restriction does not apply. Faster payment for surviving suppliers would not, by itself, establish that the policy had benefited the sector.

The incentives differ across buyers. A profitable company with a significant current tax liability has a stronger immediate reason to preserve a deduction than a business with little taxable income. A supplier offering a specialised component may withstand pressure better than one selling a standard product available from many competitors. The same legal rule can therefore produce different commercial outcomes.

Trade representatives have raised concerns about buyers avoiding registered small suppliers. Such reports identify a plausible mechanism; they do not establish its prevalence. Equally, an increase in registrations or a decline in reported overdue balances would not prove that procurement relationships had remained intact. Registration, payment speed and sales must be examined together.

There is another complication: the payment clock depends on acceptance and the handling of objections. Genuine quality disputes need room for resolution. But opaque acceptance procedures can also shift delay from an unpaid invoice to an unacknowledged delivery. Enforcement that watches only booked payables may miss the earlier stage at which a powerful buyer controls the record.

The right response is not to abandon the deadline. It is to recognise that payment regulation governs a commercial relationship, not merely an accounting entry.

Measure the invoice, not the announcement

India needs a more credible evaluation of this reform. Aggregate bank-credit growth cannot reveal whether customers are paying faster. Neither can the number of enterprises registered on Udyam. Both may improve while a supplier’s receivables remain stubbornly high.

A useful assessment would track four outcomes: time from delivery to acceptance, time from acceptance to payment, the share of invoices overdue, and changes in small suppliers’ sales to existing customers. The last measure is essential. Otherwise, a buyer that stops purchasing from small firms can appear to have solved its small-firm payment problem.

Existing administrative systems provide parts of the picture. Udyam records enterprise classification; GST systems record much formal trade; tax returns capture deductions; payment and invoice-financing platforms hold settlement information. These are not interchangeable datasets. An invoice is not proof of payment, and a bank transfer may settle several invoices. Linking records requires careful definitions, legal safeguards and protection of commercially sensitive information.

An anonymised study could compare payment behaviour before and after implementation, across buyers with different tax positions and suppliers of different sizes. It would also need to account for changing demand, enterprise classifications and other influences. Comparing covered suppliers with medium enterprises could be informative, but would not alone establish causation: the businesses may differ systematically.

Public reporting should include payment performance by government departments and public-sector enterprises. A policy asking private buyers to stop extracting credit from small suppliers gains credibility when public procurement meets the same standard of discipline.

Make prompt payment commercially ordinary

Tax enforcement should sit alongside mechanisms that make reliable settlement easier. Clear purchase orders, digitally recorded delivery and acceptance, and auditable explanations for disputed invoices would reduce uncertainty. Supplier status should be straightforward to verify, rather than becoming an annual exchange of inconsistent declarations between procurement teams and vendors.

Invoice financing can help, but it is not a substitute for payment discipline. RBI-regulated Trade Receivables Discounting System platforms allow accepted receivables to be financed through competing financiers. Their value depends heavily on buyers acknowledging invoices and participating meaningfully. A supplier cannot easily monetise a receivable that its customer refuses to confirm.

Nor should financing quietly legitimise ever-longer payment periods. Discounting has a cost. If the weaker firm routinely bears it, the buyer may still be receiving cheap credit at the supplier’s expense. The purpose should be to bridge predictable settlement periods, not to normalise indefinite delay.

Enforcement must also avoid making suppliers responsible for policing customers they cannot afford to lose. Faster dispute resolution and dependable transaction records would help make the statutory right usable. Stable, intelligible guidance matters more than repeated deadline changes that encourage businesses to postpone adaptation.

The reform should ultimately be judged by whether small firms receive cash sooner without losing viable business. India does not lack programmes promising them more credit. What many suppliers need is less demand for credit in the first place—because customers pay for what they have already bought. Turning that expectation into routine commercial behaviour would be an economic reform of considerable substance.