Income Tax reforms needed to avoid early death of many MSME companies in software and services sector

CASE: While the Govt wants to increase credit availability for MSME companies. The same Govt is currently taking away 10% of all revenues of software and services MSME companies right at the source, in the form of TDS, even if the company does not make a profit. The IT refunds are being excessively delayed. The Lower TDS deduction process MSME unfriendly.

The provision of 10% TDS deduction is completely unjustified for Startups and MSME companies. The corresponding refund and lower TDS deduction processes are time consuming and MSME unfriendly. Income Tax reforms are required to make them MSME and Startup friendly and justified. Many MSME companies are dying due to prevalent laws and corresponding practices.

TDS QUANTUM

• 25% is the rate of Income tax of MSME companies
• Typical PBT for these companies is 10-20%.
• Total net tax can’t exceed – Revenue x 20% x 25% = 5% of total revenue
• Most Startups are usually not profitable for first 5-7 years of their life – there is no justification of TDS on Startups
• Most MSMEs have PBT of not more than 10%. Therefore TDS rate of more than 2.5% is unjustified.
• 100% of revenue of software and services companies is liable for TDS deduction. Therefore 10% of their revenue is removed from their cashflows at the source itself, for a long time
• Rate of TDS for software and service companies is 10%. What sense does that rate make except that the amount is being used to finance the Govt’s cashflows?

Recommendation: Startups and MSMEs should be exempt from TDS deduction. At the most 2% TDS should be deducted if Govt is unable to agree to total TDS exemption.

TDS/IT REFUNDS

• Note the sequence and timing of events given below.
• During the FY from April to March, TDS is deducted from MSME companies
• IT returns are filed in the subsequent FY by September, which is 18 months from the start of the FY in question
• 10% of all revenue of MSME companies is deducted and held by Govt for upto 18 months
• TDS refunds are typically processed by March-April of next year (longer if scrutiny or any queries raised) which makes it 24 months from the start of deduction. Therefore 10% of revenue is held up for upto 24 months even if company does not make any profit and no income tax is due
• For software and service companies, not posting 40% or more of PBT (hardly any MSME company will qualify for that in the country) there will always be an IT refund due every year. Every software and service company doing business in India is adversely impacted by this provision

Recommendation: IT refund should be processed by IT dept within 7-14 days for filing IT return for MSME companies.

LOWER TDS DEDUCTION

• Govt has a provision for applying for Lower TDS deduction when a company claims that it will not be profitable during a FY.
• Application process requires the company to provide a list of all prospect clients and the exact amount of revenue expected from each client
• The certificate is issued naming these clients and the amounts for which lower deduction is applicable
• Can one imagine any MSME or a startup in the world being able to predict its clients and revenues with such accuracy at the start of a FY?
• This provision is designed for well established 25+ year old companies with stable and predictable income
• This provision serves no purpose for MSMEs and Startups as they’re in no position to provide such a client list with exact revenue projections
• In any case, application process requires providing provisional balance sheet of previous and next FY which takes a MSME 2-3 months to prepare during which period 10% TDS continues to be deducted
• The approval of application takes another 1 month and has subjectivity involving an officer of IT dept. In practice, for initial 3-4 month of a FY therefore 10% TDS continues to be deducted despite the provision in law for lower deduction

Recommendation: Lower TDS deduction application from Startups and MSMEs should be (a) processed based on self-certification without requiring submission of a client list (b) applicable to all clients during the corresponding FY without any revenue limit (c) processed within 7 days of application.