Digitization could ease MSMEs’ access to supply-chain finance

Access to formal credit continues to be a challenge for micro, small and medium enterprises (MSMEs). Lack of reliable financial information is one of the main reasons. Under India’s goods and services tax (GST) regime, however, significant data on the financial health of these enterprises is obtained through monthly returns, electronic invoices and e-way bills. This data can be used for financing mechanisms like the TReDS (Trade Receivables Discounting System), which is an electronic platform for facilitating the financing/discounting of the trade receivables of MSMEs through multiple financiers. These receivables can be due from corporates and other buyers, including government departments and public sector undertakings (PSUs). The receivables are confirmed by buyers through invoices (‘factoring units’) uploaded by MSMEs on the TReDS. Confirmed invoices are bid for by financiers, which include banks or non-bank lenders. Once an MSME selects the best bid, it gets paid by the financier at the agreed rate of financing/discounting. Later, the financier collects the payment from the buyer.

The creditworthiness of MSMEs can be judged from three data points on the GST system: 1) Input tax credit (ITC) being claimed by the MSME; 2) Trade volume as per the e-way bills (EWBs) created by it; and 3) Trade volume as per the electronic invoices raised by it. As for the first data point, each GST registrant files a monthly return form called GSTR-3B, in which it self-declares its tax liability and the ITC that it believes it is entitled to based on its purchases. Since the return does not provide the break-up of ITC seller-wise or invoice-wise and is based on self-declaration, it may not be appropriate for use in any financing scheme.

The second data point is the trade volume based on EWBs created by MSMEs. While this is an important data point, it only applies to manufacturers/traders that supply physical goods. Further, one EWB may correspond to multiple buyers whose confirmation is not implied in the bill’s creation. This leaves us with the electronic invoices of MSMEs generated on the GST platform. The e-invoicing requirement under the GST regime started in October 2020 for businesses with a turnover greater than ₹500 crore. This has been expanded to cover businesses with a turnover of ₹50 crore and above. In the e-invoicing system, a supplier generates a unique 64-character alphanumeric code called the IRN (invoice reference number) with details of its GSTIN, invoice date, internal invoice number. These invoices can be identified with their IRN and can be sent to the TReDS platform to be made available for factoring. Since the buyer’s confirmation is not obtained in the creation of these invoices, “recourse factoring” can be introduced on the TReDS platform. This means that MSMEs must buy back the invoices on which the financiers are unable to collect payments from buyers.

The Parliamentary Standing Committee on Finance, while reviewing The Factoring Regulation (Amendment) Bill, 2020, also recommended that the GST e-invoices above a certain threshold should flow directly to the TReDS platform. Till August 2021, around 750 million e-invoices, issued by 136,000 suppliers for almost 6.1 million recipients had been generated. These are big numbers, considering there are 24,000 MSMEs registered on the TReDS. Through the electronic filing of returns, the GST regime brought MSMEs into formal channels of compliance. However, they still need to be brought into formal credit channels by integrating the GST architecture with the TReDS and Udyam.

Such synergy can also be found in the integration of GeM (Government e-marketplace, an online platform for public procurement) with RXIL, a TReDS platform. It will help government departments, PSUs, CPSEs, etc, finance their payments to MSME sellers of goods and services. This can also be done with the data in GSTR-7 returns, which are filed by government agencies every month. This data contains the invoice amount for supply received by these agencies on which they deduct a certain amount as TDS (tax deducted at source). Since these records are generated by the buyers themselves, there is no additional need to verify them again on the TReDS platform and can directly be used as a factoring unit (the system’s nomenclature for invoices and bills of exchange) at the will of the supplier.

The linking of India’s GST system with the TReDS has other advantages as well. An EWB that is coupled with an e-invoice can act as a supporting document for a factoring unit, enhancing its authenticity. It can also provide for buyers’ acceptance, which would serve as valid proof, like a goods receipt note. Further, the GST system is supposed to develop a rating system for all taxpayers based on their tax compliance and other factors, which may prove valuable for factoring agencies on the TReDS. All these linkages will help digitize the supply chain of MSMEs, making their access to finance much easier.

As the integration of GST data with the TReDS requires GST Council approval, this agenda may be taken up by it in its upcoming meetings.

V. Anantha Nageswaran & Mahesh Singarapu are, respectively, visiting distinguished professor of economics at Krea University; and an Indian Revenue Service officer and deputy director in the Enforcement Directorate.