With many small and medium enterprises staring at bankruptcy or severe business disruption due to the Covid-19 crisis, large companies that buy raw material and products from them now have to deal with a new problem: denial of credits if the vendor defaults on paying goods and services tax.
According to the GST framework, large companies cannot claim credits unless their suppliers and vendors have paid the tax. Section 16 of the GST law says that if a vendor does not pay GST to the government, input tax credit will be denied to the buyer.
Companies with a large supplier base across sectors are now reaching out to their vendors to check if there is a possibility of a default from their side.
“The additional liability cast on businesses for ensuring payment of tax by the supplier has been a rising concern since inception because of the practical difficulties in verifying the same and the financial burden even though the tax is paid to vendors,” said Abhishek Jain, a tax partner at EY. “This obligation has drawn attention in these difficult times owing to apprehensions of defaults by vendors with the currently spread financial flu.”
The nationwide lockdown has broken the back of the SME sector. The coronavirus triggered restrictions that shut businesses abruptly and left smaller companies facing a crushing cash crunch. Major raw material and labour shortages along with a demand pullback from the industry created an existential crisis for many.
Industry experts said many large companies have been putting in place some steps to manage the situation.
“Large businesses are considering indemnity arrangements to safeguard themselves from vendor defaults arising from the extended timelines for GST payments and returns provided to smaller businesses. There is also a need to re-evaluate the vendor selection policies based on previous compliance track records,” said MS Mani, a partner at Deloitte India.
According to people aware of the matter, some companies have asked their vendors and suppliers to give them an indemnity letter.
“The letter is essentially a legal document that asks vendors to pay GST on time and be held responsible if there is a GST default or if any interest or penalty is charged to the company due to a vendor’s delay,” said one person.
Input tax credit can be claimed only after a vendor has paid the tax and uploaded the correct invoice on the GST portal. The invoices are matched with the credit eligibility of the company. Full credit is allowed if there is 90% accuracy or if there is a problem with 10% of the invoices.
A few of the larger companies, especially in the automobile and other manufacturing sectors, are not taking chances, experts said.
“Some of the large companies are holding back on payments to vendors and suppliers for two months as a pressure tactic. This is to make sure that they pay up the GST on time and the company is able to avail of tax credits,” said a tax expert who advises large companies.
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