Reclassification of MSMEs- A much-needed policy correction

Recently Govt of India had proposed to amend the classification of SMEs by linking solely to turnover. The move is a much-needed correction to address the policy needs of the segment.

Presently the MSMEs are classified as per Micro, Small and Medium Enterprises Development Act, 2006. As per this, the MSMEs are broadly classified into Manufacturing and series sector. These are further classified into micro, small and medium enterprises based on investment in plant & machinery for manufacturing and investment into equipment in respect of services sector.

The present classification is not forward-looking and beset with the challenge of closer scrutiny for extending the govt support. Because the exclusions and inclusions in identifying the eligible entities create scope for interpretation and demand inspections in some cases. These will make delivery of incentives a cumbersome and not timely

Many a time the units which are medium enterprises by the virtue of turnover and size of operation are likely to be classified as a large entity by the virtue of investment in plant and machinery.

Because many enterprises which are vendors to large companies may have set up a capital-intensive unit to add value through job-work but they may not do annual turnover equal to the value of the investment. However, by the virtue of this classification, such units are deprived of getting incentives and reliefs in distress as they are not classified as MSMEs.

These limitations are denying MSMEs rightful place in national economic development. There are many countries in the world especially developed countries where MSMEs contribute about 50% of GDP and significant employment generation avenues. In India also MSMEs hold a special place for generating employment and it is contributing to more than 30% GDP. The segment holds huge potential to create employment and increasing share in GDP.

With the introduction of GST, the manufacturing and services ecosystem will transform to become very efficient and outsourcing will accelerate in future.

Keeping in view the importance and with an aim to give more thrust to MSMEs, recently Govt of India has approved the amendment to laws leading to reclassification of MSMEs units. The Govt proposed to link classification of micro, small and medium enterprises solely on the basis of turnover. The new classifications are as follows:

The Proposed Classification:

Any type of business entity can qualify to apply for an MSME Certificate if their revenues from Annual Turnover are as under:

The government attempted to replace the investment in plant and machinery with annual turnover limit due to following reasons:

• To integrate the MSME registrations with the GST network. The government before issuing the certificates will no longer have to get into the intricacies of inspecting the investment in plant and machinery. Instead, the turnover claims can be easily verified with the GST Sales data filed with the Goods and Service Tax Portal, in no time.
• To eliminate chances of miss-calculations in self-declaration of investment
• To extend ease of doing business to micro, small and medium enterprises. By making the classification process transparent, it not only makes the registration process time effective but also evolutionary. With reliable turnover figures, any attempt to defraud can be curbed in the nip. The applicants can now easily apply for MSME registration.

Benefits for new classification:

Apart from the ease of identification as we mentioned above, the new classification brings a lot more clarity and support to the segment to grow in the future. Some of them are:

1. Elimination of distinction between services and manufacturing sectors: Most of the focus on MSME segment is pointing at manufacturing sector and services segment is treated as subservient. It is a fact that robust service sector is important for the evolution of stronger manufacturing ecosystem in the country. Secondly thanks to the greater application of information technology-based tools and approaches, the manufacturing segment is becoming leaner and competitive. Thus unifying the segments is a welcome move.
2. It eliminates the ambiguities associated with classification and makes the process simpler
3. Recent Budget proposed reduction corporate tax upto a turnover of Rs 250 crores. The new definition makes it beneficial for a large number of units.
4. Govt has already brought in Rehabilitation framework for helping MSMES to seek to restructure when in distress. Further Govt is working on a new framework for assisting distressed MSMEs to seek support. With the new definition in place, a very large number of firms who are distressed will get statutory backing to seek nursing support from banks and NBFCs.
5. The new definition will it broader and inclusive of eligible entities. This will facilitate transmission of policy support from Govt/s better and will be effective.

Apprehension relating to the increased limit:

The ceiling for classification is pegged at a higher level than otherwise expected if we try to link with the previous regime. The medium segment is pegged at Rs 250 crores. This has raised eyebrows among many and there is an apprehension that many entities otherwise not eligible may exploit the Govt policy support by the virtue of increased limit.

However, our understanding of MSME universe indicates that it is a welcome move. Because if we analyse the companies having a turnover of up to Rs 250 crores, by and large, they exhibit same characteristics as smaller firms owned by individuals and families. Most of these firms are debt funded and assets of promoters are attached for raising debt. In addition, the industry level issues and challenges affect them almost in a similar way as they affect smaller firms.

Thus we believe Govt is right in expanding the scope of definition to include the firms up to Rs 250 crores turnover.

Conclusion:

The new proposal of amending the definition of MSME segment is going to be a game changer and a much-needed correction to make MSMEs becoming more responsive to policy support and promote them to increase their contribution to GDP as well as employment generation.