GST and the MSME Sector

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Published Date:  07-12-2023   Author:   moulik-jain
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The Indian economy heavily depends on Micro, Small, and medium-scale enterprises, known as MSMEs. The small and medium enterprise sector is the economy’s growth engine, accounting for nearly 45% of manufacturing output, over 40% of exports, and over 111 million employed. However, MSMEs often search for support on financial issues, technology, access to markets, infrastructure, and regulation.

Rolled out in 2017, GST aims to create a simplified, uniform, and integrated indirect tax system in India by substituting multiple taxes levied by central and state governments. One of the key reasons for GST was to create a conducive environment for doing business to develop the MSMEs. Nevertheless, the sector has recorded mixed outcomes under the GST system.

captainbiz registered msmes in india in fy lakh units

Image Source: IBEF

This article critically analyzes the impact of GST implementation on the MSME sector. It discusses the key benefits and challenges faced by MSMEs in GST compliance. The analysis also evaluates the role of GST in facilitating or impeding the growth of MSMEs, along with suggestions for further reforms.

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GST – Concept, Framework and Intended Benefits

GST, or Goods and Services Tax, is an indirect tax regime that subsumes all indirect taxes levied on goods and services by the Central and State Governments. Implemented on July 1, 2017, GST aims to consolidate India into a unified market by replacing layers of taxes, including excise duties, VAT/CST, services tax, CAD, SAD, and additional customs duties with a simplified, consumption-based tax structure.

The GST framework is anchored around the following key principles:

  • Consumption-based Value Added Tax: GST is collected on value-addition at each stage of the supply chain with input tax credits available for tax paid on procurements.
  • Destination-Based Consumption Tax: GST accrues to the state where the final sale to consumers takes place rather than at production origin.
  • Unified Compliance Mechanism: Single registration, return filing, and tax payment interface via GST portal for Central GST (CGST) and State GST (SGST) components.

The GST tax structure intends to benefit MSMEs through:

  • Elimination of Cascading Taxes: Seamless flow of input tax credits expected to reduce production costs.
  • Unified Common Market: Subsuming all indirect taxes under GST aimed to reduce fragmentation and enhance pan-India trade.
  • Boosted Competitiveness: Simple tax regime focused on expanding MSME growth and development opportunities.

GST Registration and Compliance for MSMEs

Registration under GST entitles MSMEs to various benefits, such as seamless input tax credit, simplified taxation structure, and increased market access across India. However, many small businesses need help with compliance requirements under the GST system.

Financial Year GST Paid by MSMEs (in Rs crore)
FY20 5,00,000
FY21 4,70,000
FY22 5,50,000

Table: Amount of GST paid by MSMEs per year

Benefits of GST Registration

  • Input Tax Credit: One of the most significant advantages of GST registration is that businesses can claim input tax credit for the entire supply chain. This helps improve cash flows and working capital availability.
  • Uniform Tax Rates: GST has subsumed the complex indirect tax structure, helping create a common national market across India. The consistent tax rates reduce inconsistencies and compliance costs.
  • Ease of Doing Business: A GST-registered business is able to expand to newer markets pan-India without facing location-based disadvantages. This boosts opportunities for business growth.

Also Read: The Benefits Of Each Type Of GST Registration

Compliance Requirements under GST

While the GST regime has reduced tax complexities, it has also increased compliance for small businesses through new procedures and mandatory digital filings.

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  • Threshold Exemption: The ₹40 lakh annual turnover threshold for GST exemption helps minimize compliance burden for smaller enterprises. However, it limits their ability to claim input tax credits.
  • Composition Levy Scheme: The composition scheme with a 1-5% tax rate allows MSMEs with up to ₹1.5 crore turnover to file simplified quarterly returns. However, they lose input tax credit benefits.
  • Quarterly Filing of Returns: All registered MSMEs need to file Form GSTR-1 sales returns monthly and GSTR-3B summarized returns quarterly online, increasing reporting requirements.
  • E-Way Bills: MSMEs need to generate e-way bills for inter-state movement of goods worth over ₹50,000. This has increased transportation times and costs due to border check post verifications.

GST Registration and Exemptions

The ₹20 lakh threshold exemption limits the ability of smaller units to scale, while ₹1.5 crore turnover eligibility for the composition scheme denies them input tax credits.

  • Threshold Exemption: Units with <₹20 lakh annual turnover are exempt from GST registration. However, they are unable to claim input credits.
  • Composition Scheme: Units with <₹1.5 crore turnover can opt for composition @1-5% GST rates. However, input tax credits are not available.
  • Regular Registration: Deemed necessary for units aiming for business growth and market expansion.

Challenges in Meeting GST Compliances

Despite initiatives for easier digital compliances, procedural bottlenecks have prevailed, hampering the GST onboarding of MSMEs.

  • Multiplicity: Require separate registrations for different business verticals in each state. Annual consolidations take a lot of work.
  • Frequency: Mandates monthly GSTR-1 invoice uploads and quarterly GSTR-3B return filing. Errors lead to fines.
  • Reconciliation: GSTR-2A purchase mismatch and reporting majorly hampers working capital cycles for MSMEs.
  • Cost: Deploying skilled manpower and accounting software for compliance is expensive for MSMEs.

Also Read: Role Of GST Registration Services In GST Compliances

GST Impact on the MSME Sector

The GST regime has broadly benefitted MSMEs through lower tax incidence in several product categories, ease of logistical movement, availability of input tax credits, more comprehensive market access, and growth-oriented formalization.

Category Previous GST Rate New
I. GST rate reduction on goods at 28%
A. 28% to 18%
Video game consoles and sports 28% 18%
Monitors and TVs (up to 32 inches) 28% 18%
Power banks of lithium-ion batteries 28% 18%
Re-treaded or used pneumatic tires 28% 18%
B. 28% to 5%
Parts and accessories for carriages 28% 5%
II. GST rate reduction on other goods
Articles of natural cork 18% 12%
Cork roughly squared or debagged 18% 12%
Marble rubble 18% 5%
Natural cork 12% 5%
Walking Stick 12% 5%

Table: Difference in GST rates for multiple categories

However, procedural complexity, revenue uncertainty during transitions, infrastructural bottlenecks like difficult portal access, and delayed refunds have also temporarily hampered the smooth onboarding of MSMEs into the GST ecosystem.

Key Positives

  • Tax Burden Reduction: GST rate lower than total previous indirect taxes for major job-creating sectors like leather, gems & jewelry, textiles, furniture, etc., providing cost savings for producers and consumers.
  • Logistics Efficiency: Faster movement of goods through check posts, lower fuel costs via input credit, and unified e-Way bills improve overall logistical efficiency.
  • Cascading Taxes Reduction: Subsuming multi-point levies like octroi, entry tax, etc., into GST eases the production cost burden arising from tax on tax for MSMEs.
  • Access to Pan-India Market: Compared to multiple Central and State registrations earlier, a single permit requirement enables access to a more significant customer base across India.
  • Formalization: The availability of input tax credits incentivizes informal units to grow their customer base by registering under GST.

Key Negatives

  • Procedural Complexities: Technical glitches on the GSTN portal, invoice mismatches, and delays in tax refunds have increased process complexity for MSMEs.
  • Revenue Uncertainty: Loss of fiscal autonomy for manufacturing states with origin-based taxes replaced by destination consumption-based tax under GST reduces income predictability.
  • Infrastructure Bottlenecks: Erratic GSTN portal access, lack of adequate API integration, and refund delays have caused significant blockage of working capital for MSMEs.
  • Cash Flow Constraints: The absence of input tax credit carryforwards and reimbursement of interest for delayed refunds hamper production viability due to strained cash flows for MSMEs.

The GST ecosystem holds substantial growth potential for MSMEs, provided teething transitional challenges are holistically addressed through coordinated policy initiatives focusing on simplifying procedures and access to formal credits.

Also Read: Understanding the Impact of GST on Indian Startups: Compliance and Benefits

Role of GST in Facilitating MSME Growth

While GST disrupted MSMEs in the short term, several pathbreaking reforms have been introduced to nurture MSME productivity and competitiveness, helping them integrate into the economic and export value chain.

Market Access and Competitiveness

  • GeM (Government e-Marketplace): The dedicated online public procurement portal has over 46 lakh MSME product and service offerings, improving visibility and enhancing access to government departments.
  • PSU Procurement Mandates: Mandating 25% procurement of inputs by PSUs from MSMEs has opened more extensive revenue opportunities.
  • Capital Access Reforms: Collateral-free loans under CGTMSE, reduced corporate taxes, and equity funding via revised Funds-of-Funds operations focused primarily on MSMEs.
  • Unified Logistics Interface Platform (ULIP): Integrates information available with various agencies across roads, rail, and waterways to enable transparent, foreseeable, and competitive logistics costs for MSMEs.
  • National Logistics Policy: Proposed reforms include unified cabotage laws to lower freight costs and minimum warehousing standards to allow pan-India trade access to MSMEs.
  • Exporter ID Card: Improves export ease for MSMEs by facilitating customs clearances, foreign trade policy incentives, and trade-related documentation.

Digitization

  • Aadhaar Authentication: The eSign/Aadhaar-based trust mechanism for new GST registrations has simplified and secured the onboarding of MSMEs.
  • Grievance Redressal: An RFID-based intelligence engine for verifying irregularities provides targeted resolution of mismatches in purchase filings by MSMEs.
  • GST Saathi (Help) App: Provides essential registration requirements, nil filing facilities, document upload mechanisms, payment options, etc., via Android and iOS mobiles.
  • Cash Ledger and Challan Reconciliation: Automated utilization of available cash balances for GST payments and tax head-wise analytics prevents duplicate challan generation – a key area of fines for MSMEs.

Analytics Adoption

  • GSTN Analytics: Allows turnkey analytics like input tax credit reconciliation, establishing tax liabilities through self-declared income estimates, and highlighting supplier network gaps for MSMEs.
  • ULIP Analytics: Enables accurate demand assessment, optimizes inventory requirements, and allows competitive logistics cost bargaining for MSMEs through data-based decision-making regarding freight routes.

These pathbreaking initiatives around digitization, analytics adoption, and trade facilitation, coupled with awareness drives under capacity-building programs like SPEED MSME focused on skilling MSME leadership teams on best practices around GST compliance, export promotion, procurement contracts, and validating product quality, will catalyze the next wave of growth and employment generation through competitive MSMEs under the GST regime.

Conclusion

Implementing Goods and Services Tax (GST) has had a transformative impact on the Micro, Small, and Medium Enterprises (MSMEs) in India. The new tax regime has dismantled geographical barriers for MSMEs, enabling access to broader markets across India and empowering them to compete effectively with more prominent players.

By eliminating the cascading effect of multiple taxes and facilitating seamless input tax credits, GST has helped reduce production costs for the MSME sector. Further, aspects like a national common market, composition scheme, and export incentives have allowed MSMEs to enhance their capacity utilization and broaden revenue opportunities.

Despite some early transitional glitches regarding procedural complexities, revenue uncertainty, and infrastructure constraints, concerted efforts have been made to alleviate pain points for MSMEs through tax rationalization and reforms focusing on easier digital compliances, timely refunds, and single-window dispute resolution processes.

With MSMEs emerging as significant contributors to exports and employment in recent years under GST, there is tremendous potential for further growth through sustained policy initiatives to ease tax compliance burdens and access to formal credit for small businesses. By proactively nurturing MSME competitiveness, India can leverage the GST regime to catapult MSMEs as globally integrated drivers of innovation and engines of economic growth.

FAQs

  • What are the key benefits of GST for MSMEs in India?

Some significant benefits include – the seamless flow of input tax credit, simplification of tax structure, reduction in multiplicity of taxes, unified common market across India enabling access to a broader consumer base, improved logistics, and lowering of transportation costs due to abolition of check post clearances after e-Way bills.

  • How is GST compliance under the composition scheme beneficial for MSMEs?

The composition scheme with low flat tax rates allows MSMEs with turnover below ₹1.5 crore to quickly meet compliance burden, though it restricts their ability to claim input tax credit. It provides them with an easier transition option into the GST ecosystem.

  • What are some key challenges faced by MSMEs under GST?

Key challenges include complex procedures for return filing, frequent technical glitches on the GSTN portal, delays in tax refunds blocking working capital, cascading taxes for unregistered businesses, and lack of adequate awareness and preparedness for record-keeping requirements under GST.

  • How does GST registration impact access to finance for MSMEs?

GST registration provides access to collateral-free loans by enhancing the creditworthiness of MSMEs in front of banks and NBFCs. It also allows them to bid for orders from government units, as supplier registration eligibility necessitates GST compliance.

  • How does GST help MSMEs improve their competitiveness?

GST provides a level playing field for MSMEs to compete across India by reducing location-based tax disadvantages. By addressing earlier market fragmentation, GST enables MSMEs to access broader markets.

  • What measures have been taken to alleviate GST challenges for MSMEs?

The measures include introducing an e-Way bill threshold exemption limit, increasing the threshold for composition scheme and for exemption from registration, launching the GST Saathi mobile app for easier access, rationalizing tax rates, introducing measures for quicker refunds, and improving dispute resolution mechanisms under the law.

  • How does GST promote the formalization of the MSME sector? 

The availability of input tax credits and a simplified compliance mechanism incentivize informal and unregistered MSMEs to become part of the GST ecosystem to enhance their competitiveness and gain more significant market access.

  • What is the outlook post-GST for the export potential of Indian MSMEs?

By resolving domestic indirect tax inefficiencies, GST reforms have helped Indian MSMEs improve underlying competitiveness. This, along with the MEIS scheme, stable exchange rates, and rising outsourcing from China, positions Indian MSMEs strongly to expand exports.

  • How does GST help MSMEs improve their supply chain effectiveness?

GST allows MSME suppliers and distributors to source raw materials and transport finished products across state borders without tax disadvantages, thus reducing inventory and logistics costs. This helps them enhance overall supply chain efficiencies.

  • What impact has GST had on MSME sector job creation?

While GST initially created disruptions that slowed job creation, the sector’s greater formalization of MSMEs, growth benefits from wider market access, improved competitiveness, and supply chain efficiencies have upheld medium-term job creation.

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Moulik Jain

I am a seasoned marketer specializing in Tax, Finance, and MSMEs who brings a wealth of hands-on experience to demystify complex subjects, providing insightful guidance for entrepreneurs and finance enthusiasts alike.

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