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How India shackles its small businesses

According to industry estimates, the cost of adopting technology solutions to ease the burden of tax compliance is in the range of  ₹12,000-24,000 a year for a small retail shop.  (Photo: Mint)Premium
According to industry estimates, the cost of adopting technology solutions to ease the burden of tax compliance is in the range of 12,000-24,000 a year for a small retail shop. (Photo: Mint)

  • At a time when MSMEs are struggling, the Centre’s tech-driven thrust on tax compliance has made things worse.
  • While systemic issues were prevalent even before, they matter far more in 2021—when recovering MSMEs have been walloped yet again by a period of uncertainty due to covid-19.

NEW DELHI : Towards the end of 2017, an entrepreneur based in Noida spent 12 lakh and bought a commercial truck for the fly-ash based construction materials plant that he runs in the satellite town on the eastern outskirts of New Delhi.

The businessman received a jolt when he learned that an error by the truck dealer in uploading the invoice onto the Goods and Services Tax (GST) Network—the dealer identified it as a retail sale when it was a business-to-business transaction—would cost him dearly.

Because the dealer could not rectify the error before the close of the financial year in March 2018, the 38-year-old entrepreneur, who didn’t want to be identified because it involves a tax matter, had to pay back to the government the entire input tax credit of 2.5 lakh that his company had claimed for the purchase.

Almost four years after the GST—billed as the biggest tax reform since independence but criticised for its flawed implementation—came into force, such losses remain a pain point for industry.

Sustained tightening of rules, particularly over the last few months, aimed at making the system more transparent is increasingly touching the lives of small businesses. And while systemic issues were prevalent even before, they matter far more in the summer of 2021—when recovering small and medium enterprises have been walloped yet again by a period of uncertainty due to the second wave of covid-19.

One key enduring worry for small and big businesses alike is a restriction on taking credit for the GST paid on raw materials and services if the seller has not yet deposited the taxes collected with the government. What is the sanctity of an invoice issued by the seller or of an electronic permit generated by an official website for transportation of goods if these are not enough for the buyer to claim credit for the taxes he or she paid, asked the businessman quoted above.

“If nobody honours an invoice, what is the need to invest in computerised billing systems?" he wondered.

An email sent to the spokespersons for the finance and corporate affairs ministries and to the office of the revenue secretary seeking comment for this story remained unanswered.

A regulatory trend

Because the responsibility for collecting indirect tax and paying the government falls on the seller in most cases, buyers depend on the seller’s compliance to get credit for the taxes that they paid. The authorities find it hard to grant the credit if they have not received it from the seller. Since October 2019, GST authorities have scaled back the extent of tax credits available to businesses where suppliers have not uploaded details. Now, it is capped at 5% compared to 20% earlier.

In the case of a capital goods purchase, if the seller does not upload the details of a sale, the buyer is unable to claim a depreciation benefit for it.

The troubles that plague micro, small and medium enterprises (MSMEs) point to a regulatory trend which was designed with honest intentions—of bringing more transparency to transactions and creating a digitised economy under the penetrating gaze of a tech-driven regulatory ecosystem.

The government’s intention is to improve its oversight of businesses, raise the quality of corporate governance, and improve India’s historically low tax compliance, which will in turn help lower tax rates for all. But many MSMEs find that journey arduous, if not perplexing.

The unfinished nature of GST, the cost of hiring consultants to handle compliance, the sustained tightening of tax rules and what firms describe as a “not so friendly user interface" of the GST Network are all making life unnecessarily difficult, entrepreneurs complain. With the income tax department, GST authorities and the Customs department increasingly sharing data on transactions in the economy, mismatches have to be avoided at all cost.

Steps to improve transparency are welcome but genuine businesses should not get hurt in the process, industry representatives said. “If we are able to plug leakages and prevent instances of fraud, that is a good thing but if genuine taxpayers are criminalised as an unintended consequence, it is not a good thing," said Sanjay Aggarwal, president of the PHD Chamber of Commerce and Industry. “In general, the compliance burden on MSMEs should come down—whether it is GST, income tax or even on banking."

More and more companies have been made to report business-to-business transactions in real time to a portal run by the National Informatics Centre (NIC) for greater oversight of economic activity and to check GST evasion.

This requirement, first brought into effect in October 2020 for businesses with 500 crore of annual sales, applies to those with 50 crore in sales from 1 April 2021. The government’s idea is to make it applicable to all eventually.

PHD Chamber, meanwhile, has been pressing for various compliance requirements to be eased. Doing away with the requirement of a separate GST registration in each of the states a business operates is one of them. Lowering the threshold for presumptive taxation—levying tax on small businesses that are not required to keep books of account on the basis of an estimate—is another.

Pain points

At present, businesses with sales of 2 crore and less can sign up for presumptive taxation and 6% or 8% of their gross receipts will be treated as their income subject to riders. Businesses want the sales threshold to be raised. Lowering the threshold for tax audits is yet another demand.

“These are pain points. Individually, they may not seem to be much but their cumulative impact on business is large. The point is, MSMEs are in bad shape now and need a lot of support," said Aggarwal.

The tech-enabled regulatory oversight regime covers everything from individual transactions to invoices, tax returns and the way books of accounts are maintained. In March, the corporate affairs ministry introduced a change in the bookkeeping norms that mandated compulsory use of software that preserves audit trails.

Responding to pleas from the industry for more time, the government quickly deferred it to 1 April 2022. The new software requirement mandates that every company that has an accounting software to maintain books should use only software capable of recording the audit trail of each and every transaction.

With technology emerging as the backbone of the oversight push, there is one big winner—business fintech firms that marry technology and legal expertise to help businesses stay on the right side of the law. For these entities, the increasing compliance and disclosure standards are proving to be a major opportunity.

Tax technology has become a key vertical in the business of many advisory firms. The technology and software tools that they offer plugs into their clients’ business management software and guides them by generating a calendar of tax due dates and other requirements under various state and central laws.

Although there are numerous central and state laws, businesses have to give special attention to about 150 key laws that they need to follow strictly, according to consultants.

According to Kapil Rana, founder and chairman of HostBooks Ltd, a service provider, the potential market is huge with around 50-55 million small businesses operating in the country.

“Prior to GST introduction, the market was scattered since different states had different tax structures. With GST, the market got integrated and got a fillip," said Rana. HostBooks has about eight products which can be used individually for different functions or could be adopted as a single solution.

It is not only consultants who gain from the transformation of the regulatory landscape though. Remaining fully compliant improves a businesses’ access to credit. They can also access finance on the basis of receivables. “As enterprises try to grow their business and become financially sound, it is imperative that they follow high transparency standards," said Archit Gupta, founder and chief executive officer of ClearTax, a tax and financial services software platform.

Indeed, many small businesses want to remain compliant but what dissuades them is the cost. According to Mukul Shrivastava, partner, forensic and integrity services, at EY, a large number of organisations have the intent to remain compliant with statutory requirements but are not prepared to make the necessary investments because of the cost that it entails.

According to industry estimates, the cost of adopting technology solutions in the case of a small retail shop is in the range of 12,000-24,000 a year and in the case of a business with up to 10 crore in sales, it is in the range of 30,000-50,000.

“The intention is not to evade, and they will generally rectify a breach as soon as it is identified by them, or when the authorities send any intimation. Their weakness is that they do not know what all to comply with, and hence this is more in the nature of trial and error," said EY’s Shrivastava.

Impact on exchequer

Sustained efforts to step up tax compliance has had a telling effect on GST receipts. Central and state governments collected a record 1.41 trillion in GST in April in spite of the second wave of the pandemic, which induced lockdowns in several parts of the country. Since October, GST revenues have stayed above 1 trillion each month.

According to the government, effective tax administration, deep data analytics and closer monitoring against fake-invoicing have contributed to the improvement in GST receipts along with a nascent economic recovery.

Industry watchers, however, point to other possible reasons too—an increase in commodity prices, among others. Basic metal prices, for instance, have been rising at double-digit rates year-on year since December and the increase was 16.6% in March and 19.25% in April, official data showed.

When primary articles become costlier, it tends to push up downstream product prices too. Industry watchers also point to the trend of high spending during election months as a possible factor for improved tax collections. Also, year-end efforts by businesses to meet sales targets in March would have helped in improved collections in April. Taxes for March sales are collected in April.

It remains to be seen whether GST collections will sustain the growth momentum. Official data showed that the electronic permits generated for movement of goods had contracted by around 17.5% in April from the level seen in March. Taxes for April sales is due in May.

To be sure, there have been some beneficial fallouts too from the tech-driven push to transform the regulatory architecture. Tax return forms—both GST and income tax—will increasingly come pre-filled.

Another example is the availability of faceless income tax assessments—a way of electronically processing tax returns which get picked up for scrutiny without a personal interface between a taxpayer and officials.

Cases are selected for scrutiny for various reasons, including mismatches, discrepancies or suspected tax evasion. Only in about 8-10% of all the faceless assessment orders issued so far has any addition of taxable income been made, Mint reported on 8 April quoting Central Board of Direct Taxes (CBDT) chairman P C Mody.

Also, the corporate affairs ministry is working on a plan to start adjudication of company law violations that are compoundable in nature—offences in which the charges are dropped in return for the payment of a penalty—entirely in the virtual mode by the Registrars of Companies and Regional Directors starting October.

But despite these gains, many MSMEs will inevitably find it difficult to sink time and effort into onerous regulatory mandates, even as they struggle to stay afloat in the months ahead. The second wave of the pandemic has put a bigger burden on small businesses. MSMEs are on a tight spot today, said PHD Chamber of Commerce’s Aggarwal.

“Considering that wide swathes of the country are under movement restrictions, there has been a substantial fall in demand. On the one hand, MSMEs have lost a lot of migrant workers and they do not have orders. It has become difficult," he said.

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