New Classification of Micro, Small and Medium Enterprises

The Union Cabinet chaired by the Prime Minister Shri Narendra Modi has approved change in the basis of classifying Micro, Small and Medium enterprises from ‘investment in plant & machinery/equipment’ to ‘annual turnover’.

This will encourage ease of doing business, make the norms of classification growth oriented and align them to the new tax regime revolving around GST (Goods & Services Tax). 

Section 7 of theMicro, Small and Medium Enterprises Development (MSMED)  Act, 2006 will accordingly be amended to define units producing goods and rendering services in terms of annual turnover as follows:

• A micro enterprise will be defined as a unit where the annual turnover does not exceed five crore rupees;
• A small enterprise will be defined as a unit where the annual turnover is more than five crore rupees but does not exceed Rs 75 crore;
• A medium enterprise will be defined as a unit where the annual turnover is more than seventy five crore rupees but does not exceed Rs 250 crore.
• Additionally, the Central Government may, by notification, vary turnover limits, which shall not exceed thrice the limits specified in Section 7 of the MSMED Act.

             At present the MSMED Act (Section 7) classifies the Micro, Small and Medium Enterprises (MSMEs) on the basis of investment in plant and machinery for manufacturing units, and investment in equipment for service enterprises. The criterion of investment in plant and machinery stipulates self declaration which in turn entails verification if deemed necessary and leads to transaction costs.
             Taking turnover as a criterion can be pegged with reliable figures available e.g. in GST Network and other methods of ascertaining which will help in having a non discretionary, transparent and objective criteria and will eliminate the need for inspections, make the classification system progressive and evolutionary, help in overcoming the uncertainties associated with the classification based on investment in plant & machinery/equipment and employment, and improve the ease of doing business. In addition the amendment will provide flexibility to the Government to fine-tune the classification of MSMEs in response to changing economic scenario without resorting to the amendment of MSMED (Micro, Small & Medium Enterprises Development) Act.
The change in the norms of classification will enhance the ease of doing business. The consequent  growth and will pave the way for increased direct and indirect employment in the MSME sector of the country.
discussion…………………………….

The Micro Small & Medium Enterprises (MSMEs) are defined in India under the MSMED Act 2006 on the basis of capital investment made in plant and machinery, excluding investments in land and building.

old criteria….……..[As per 2006 definition, Manufacturing units having investment below Rs 25 lakh (Rs 2.5 mn) were termed Micro, those between Rs 25 lakh and Rs 5 crore (Rs 50 mn) termed as Small and from Rs 5 crore to Rs 10 crore (Rs 100 mn) as Medium. Similarly, for Service units, corresponding investment thresholds were upto Rs 10 lakh (Rs 1 mn) Micro, between Rs 10 lakh to Rs 2 crore (Rs 20 mn) Small and between Rs 2 crore to Rs 5 crore (Rs 50 mn) Medium ]

From time to time, the MSME sector has been raising a demand for revision / amendment in the MSME definition. Recently the Cabinet has approved a draft which proposes to change the definition of MSMEs. The highlights of the proposal are:

It does away with investment criterion and instead proposes to define MSMEs on the basis of annual sales turnover

There is no distinction between manufacturing and service unit.

The proposed thresholds are: Micro- up to Rs 5 crore (Rs 50 mn); Small- up to Rs 75 crore (Rs 750 mn) and Medium- up to Rs 250 crore (Rs 2.5 bn).

However, it is currently a proposal that Government has agreed to. To be effective, the proposal will need amendment in the MSMED Act and passed through the Parliament.

A question being asked in many quarters is why was the change in definition required? I posit four reasons.

Firstly, the definition was freezed in 2006. After 12 years, with continued erosion of value of Rupee, the thresholds have become impractical. Adjusting for inflation would have required to enhance the limit by 2-3 times.

Secondly, many sectors where MSMEs have substantial share such as Pharmaceuticals, Auto-component, Food processing among others have been demanding a many-fold increase in the investment limit needed to be compliant of the new mandatory and industrial standards. The de minimis investment exceeded at least five crore even if one had low turnover.

Thirdly, the investment based definition creates an uneven field for older enterprises vis a vis new enterprises. Setting up a unit to produce a product today would require several times more investment than the one set-up ten or twenty years ago to produce the same product with similar quantity. What could be a micro unit because of historical investment figures, would become medium or large if set up today. It becomes a barrier for new entrants.

Finally, to prove that a unit fell in a specific category, the MSMEs ran around CAs to certify the value of plant and machinery. It is alleged that many large enterprises also under-reported the investment, got CA certificate and partook in the Public Procurement ear-marked for MSEs.

Therefore, change in criterion of defining MSMEs has been considered using Turnover as the basis. The advantages of having such a definition could be:

The Turn-over based criterion resolves many of the ills of earlier regime. It is transparent, as authorities could always cross check the turnover through platforms such as GSTN. No CA certificate would be required.

Secondly, it also levels the field for new and old enterprises as the comparison is not between historical investments and current investments but between current turnovers.

It would be realistic also: after inflation adjustment the definition of small enterprise on the basis of investment would have been Rs 15 core today. Keeping turnover five times the investment, a very conservative figure, we have Rs 75 crore as a threshold which is what is proposed in the new definition.

But there is flip side too. There are few sectors where investment is low but turnover is high for example gems and jewellery units, units producing Aluminium conductor steel-reinforced cable (ACSR) among others. Many of the units have been under small category owing to investment criteria but having high turnover ranging from Rs 100 to 30 crore. They enjoyed benefits under Public Procurement Policy for MSEs which mandates 20% set-aside for Micro and Small Units in all central government purchases. Suddenly, the reserved pie of the cake is out of their reach. The PPP for MSE would not be available for units having more than Rs 75 crore annual turnover.

Keeping in view that in the proposed thresholds, there would be hardly any Micro and Small unit that could participate in high volume government tenders, it has been proposed by FISME that where smaller units have not bid, the reserved category benefits could be passed on to Medium enterprises.

One criticism about the new definition is that India still does not take into account the number of people employed. Globally, the two most important elements used to define MSMEs remain turnover and employment. I think the decision for not including the employment criterion may be because of inability of the system to cross check employment figures in a transparent manner. The practice of underreporting number of people employed is widespread especially in smaller units to remain below the threshold of 10 employees to save on very high social security and compliance costs. Lack of labour reforms has exacerbated the situation. Adding such a criteria would have led to more paper work and corruption.

Overall, the new definition is a vast improvement over the earlier definition and should help MSMEs to face new challenges in a better frame.