MSME Classification and Definition

Government provides various incentives to small businesses for their growth. This Micro, Small & Medium Enterprises (MSME) acts as a crucial factor for the growth of an Economy. They are also important medium of employment generation.   Government has introduced MSME scheme, under which it classifies an organization as micro, medium or small. And based on this classification it provides various incentives to these organizations.

Definition of MSME

MSME is governed by The Micro, Small and Medium Enterprises Development Act, 2006.

It is under regulation of Ministry of Micro, Small and Medium Enterprises.

A micro, small and medium enterprise means an enterprise classified as such under MSME Act, 2006.

So to know the meaning of MSME, you need to check its classification.

Classification of MSME

Section 7 of MSME act, 2006 provides for Classification of MSME.

By notification No. S.O. 2119(E) dated 26/06/2020, the classification criteria is changed.

To classify under MSME, first you need to check whether you are manufacturing or Service sector, based on your business activity.

Once you decided it, and then look into below table for further classification.

The new classification criteria as per notification are mentioned below:

Here investment for Manufacturing means investment in plant and machinery in previous year.

And investment for Service Sector means investment in Equipment in previous year.

How to calculate investment for MSME Classification?

Investment in plant and machinery or Equipment is taken from Income tax return(ITR) of previous year.

For example, if ABC Ltd., a IT company, filed ITR of FY 19-20, and in this return it shows value of Equipment is Rs. 25 Lac.

In year 20-21, ABC Ltd. will be classified as micro enterprise.

In case, where no ITR is filed, value of investment is calculated based on self declaration basis taking into account the purchase value of such investment excluding GST.

Plant and machinery or Equipment means as defined in income tax rules, 1962. It includes all tangible assets except land and building, furniture and fittings.

The cost of items mentioned in    explanation 1 of Section 7(1) of MSME act is also excluded from value of investment. The explanation is mentioned below:

The cost of pollution control, research and development, industrial safety devices and such other notified items, if any, are excluded from value of investment.

How to calculate turnover for MSME Classification?

The turnover is taken from the GST return filed for previous year.

It is important to note that, any export turnover of goods/services is excluded for calculation of turnover for MSME classification.

If an enterprise is not having PAN, then turnover based on self declaration is taken. This relaxation is upto 31^st March, 2021. Thereafter PAN and GST number is mandatory.

Composite Classification Criteria for MSME

Composite criteria means both investment and turnover are considered are considered to  re-classify an enterprise as micro, small or medium.

This table is same as above classification table, given here to understand the composition criteria.

As per composition criteria, if an enterprise crosses the ceiling limit of turnover or investment it will be placed in next higher category.

For example, ABC Ltd., a IT company (service sector), in FY 19-20, is having investment of Rs. 50 Lac and turnover of Rs. 4 crore.  It will be categorized as micro enterprise.

If in FY 20-21, it has investment of Rs. 70 Lac and turnover of Rs. 6 Crore, it will be placed in next higher category i.e small enterprise.

Again, as per composition criteria, if an enterprise turnover or investment goes below the ceiling limit, it won’t be put into lower category unless both turnover and investment goes below ceiling limit.

For Example, XYZ Ltd., a manufacturing company, in FY 19-20, is having investment of Rs. 11 crore and turnover of 60 crore. It will be categorized as medium enterprise.

In next financial year, its investment declined to Rs. 6 crore and turnover is of Rs. 70 Crore. In this case, it won’t be put in lower category of small enterprise since turnover is still above ceiling limit of Rs. 50 crore.

It is important to note that under composite criteria, all turnover or investment is taken as aggregate of all units under same PAN even if they have different GST number, for classification of MSME.

How classification of MSME is updated?

Based on information filed in income tax return for investment and in GST return for turnover, the classification is updated.

In case an enterprise if re-classified to below category or above category, a communication will be sent to the enterprise.

In case of upward change/re-classification, an enterprise will maintain its prevailing status till expiry of one year from the close of the year of registration under MSME act.

In case of downward change/classification, an enterprise will continue its present category  till the closure of financial year and benefit of changed status will be given after 1^st April following the year in which change took place.

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CA Harish Negi

Hey readers, welcome to my blog investsaver.com. I am Chartered Accountant by Profession and I love to write on tax & money matters. You may ask your queries through comments related to the topic, I will be happy to answer them.

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