GST cuts may block capital for small businesses. Here’s how

This is because such firms would have paid GST to their suppliers at a higher rate under the older regime. However, when they sell their inventory to customers, they would receive tax at the newer, lower rate. So their tax liability would be less than the input credit they receive, blocking working capital as credit on their GST ledger.

The impact will be acute for micro, small and medium enterprises (MSMEs) engaged in the distribution of consumer goods as they, along with retailers, typically operate on slim profit margins of 3–5%.

The blocked capital could take from weeks to upwards of a year to offset for a firm depending on the size of its inventory and margins, experts pointed out.

Companies get credits for taxes paid on inputs that go into their businesses, and these can be set off against future liabilities.

The accumulation of excess input tax credit has been an issue in the past, too, whenever the tax rate on any item was rationalized. However, considering the rates have been slashed simultaneously for items across the board, this makes it a much bigger challenge, they said.

“Inventory bought at higher GST and sold at concessional rates locks up credits that cannot be recovered,” said Kulraj Ashpnani, partner at tax consultancy firm Dhruva Advisors. “GST rationalisation is a welcome move, but unless refunds are allowed, dealers end up with stranded credits on stock bought at higher rates. The government must step in with a refund mechanism to ensure fairness.”

Retailers face immediate cash crunch

Consider this simplified example. A retailer selling household items like hair oil, shampoo, soap and toothpaste will have paid 18% GST when stocking up its inventory. Now, when they clear this inventory after 22 September, when the new tax rates become effective, customers will pay only 5% GST on these items.

If such a retailer has an inventory of ₹10 lakh, they would receive roughly ₹1.53 lakh as input tax credit on this. However, assuming a 5% margin, their GST liability would be only ₹52,500 as against ₹1.89 lakh under the older rates. This translates to about ₹1.05 lakh being stuck as unutilized input tax credit, which could take months to offset.

“Our profit margins are in the range of 3–5%, but with this change, the extra tax already paid on inventory gets stuck. For MSMEs, this creates immediate pressure on cash flows,” said Lalit Agarwal, chief executive of value retail chain V-Mart. While he welcomed the reform, he expressed that smaller businesses may need short-term support to manage the transition.

Long-term boost for manufacturing

Shreekant Somany, managing director of Somany Ceramics, said that the tax reform aligns with the government’s push for domestic manufacturing.

“There will be issues for the next two or three months, but the big picture is very good. This reform really provides a strong impetus to Indian manufacturing and the ‘Make in India’ vision,” he said. He is a former chairman of the National MSME Council at the lobby group Confederation of Indian Industry (CII).

The timing of the rate cut just ahead of the festive season is expected to support consumption, he said. “…Of course, MSMEs have tighter cash flows, but these are transitional difficulties that will get sorted out.”