Technology troubles notwithstanding, a key challenge that small and medium enterprises (SMEs) are faced with in the goods and services tax (GST) era is the need for increased working capital.

Ambiguous GST filing processes have caused temporary disruption for SMEs as their clients are delaying payments seeking clarity on invoice-matching process, resulting in stretched working capital requirements.

Under the new tax regime, SME exporters have to first pay integrated GST and seek a refund only after goods are exported. Also, firms with annual revenue of more than Rs20 lakh (Rs10 lakh in northeastern states), which are now under the tax net, will need additional funds. Add to that, higher compliance cost and greater interdependence on the supply chain to claim input tax credit.

Overall demand is subdued and margins are already under pressure due to surging raw material prices. So the fear is that the profitability and debt profiles of SMEs may get adversely impacted if they fail to pass on the increased tax burden to customers, particularly in the services sector.

Also, GST has come close on the heels of demonetization, which already impaired balance sheets of smaller and mid-sized firms, resulting in ratings revisions.

“There were downward revisions in cases where businesses were impacted post demonetization. Also, in our assessments, we factored in the anticipated slowdown in business growth during the second half of FY17 and impact on credit profile," said R. Vasudevan, business head at Crisil SME Ratings.

Post-demonetization, during the six-month period from November 2016 to April 2017, CARE Ratings Ltd upgraded 165 SMEs and downgraded 185 out of total rating reviews of 1,721 SMEs undertaken in this period.

“The rating upgrade to downgrade ratio stands at 0.99 time, thereby reflecting higher number of downgrades as compared to upgrades have taken place after demonetization. On the other hand, the ratio of rating upgrade to downgrade was 1.05 times during the immediate seven months before demonetization," said Yogesh Shah, director (corporate ratings) at CARE Ratings.

Though GST implementation was not a sudden event like demonetization, its complex rate structure, rules and automated filing system make transition to the new law challenging, especially for SMEs.

According to the government, 7.2 million taxpayers migrated to GST from the earlier tax regime and an extra 1.8 million new assessees were added. Of the 5.9 million who were due to file their returns by 25 August, 3.8 million—representing 64.4%—paid taxes by the 25 August deadline.

Several businesses may not have been able to file returns in time as clarity on transition credits was provided quite late, tax experts said, adding that some uncertainty on the level of compliance is likely to remain for now.

According to Vasudevan, organized companies are showing signs of smoother transition, but unorganized ones are facing a tough time. Sectors with a large share of unorganized firms including textiles, leather and logistics will require a longer duration to adapt to the GST ecosystem, he added.

To conclude, analysts are not ruling out credit downgrades for SMEs if they are unable to cope with the new business environment within a few months.

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