Change in MSME definition: Does it help the sector?

The union cabinet recently approved a change in the definition (see Table 1) of Micro, Small and Medium enterprises (MSME), to base it on their turnover as against investment in fixed assets. The Micro, Small and Medium Enterprises Development Act, 2006 will be amended accordingly to reflect the new definition. A change in definition of MSME assumes significance as it is used to provide a number of incentives such as capital, interest and technology/market promotion subsidy by the central and state governments.

Table 1: MSME definition
EnterpriseEarlier definitionNew definition
MicroManufacturing enterprises: Investment in plant and machinery< INR 25 lakhs
Service enterprises: Investment in equipment/machinery<INR 10 lakh
Annual Turnover< INR 5 crore
SmallManufacturing enterprises:Investment in plant and machinery between INR 25 lakhs and INR 5 crore
Service enterprises:Investment in equipment between INR10 lakhs and INR 2 crore
Annual turnover between INR 5 crore and INR75 crore
MediumManufacturing enterprise: investment in plant and machinery between INR 5 crores and 10 crore
Service enterprises: investment in equipment between INR  2 crores and 5 crores
Annual Turnover between INR 75 croreand 250 crore
Note: Turnover of enterprises is likely to be calculated based on GST returns

The new classification may result in many medium enterprises being classified as small enterprises (or small getting classified as micro) based on their turnover. Such reclassification would be positive for enterprises in sectors such as engineering, machine fabrication, apparel, construction contractors etc, where a large number of MSMEs are vendors to public sector enterprises (PSUs). These PSUs reserve 20 per cent of their procurement requirements for micro and small enterprises.

Further, a turnover based definition coupled with incentives for filing GST will encourage MSMEs to file taxes and transact through bank accounts, resulting in improved information availability on the sector for the policy makers. The GST filings of 2017-18, already show an increase of almost 50 per cent in the number of unique indirect tax payers.

The most significant impact though would be on state governments who would now have to revise their industrial policies that currently offer incentives to new enterprises based on their investment in plant and machinery. These policies could broadly be divided into two categories:

  • Capital investment subsidies (subsidies on machinery, building); and
  • Interest related subsidies where loans given to micro and small enterprises attract lower interest rates.

For example Government of Telangana offers Interest subsidy under Pavala vaddi on the term loan taken for fixed asset by new micro and small enterprises. The amount of loan is currently governed by the investment guidelines as defined by the MSME Development Act, 2006. This scheme may have to beredesigned to reflect the new MSME definition. Similarly, central government schemes such as PMEGP (Prime Minister Employment Generation Programme) that provide subsidy to micro and small enterprises will also have to be revised accordingly.

As such, the change to a more transparent mechanism based on turnover is a welcome step as it would make it easier for MSMEs to grow and transition from micro to small and medium enterprises. Further, unlike earlier definition which incentivised enterprises to remain small (as the incentive decreased with the increase in fixed assets), the new definition would likelystimulate investment in the sector.

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