The number of entities registered as Micro, Small, and Medium Enterprises (“MSME”) is growing every day as a result of different government incentives for MSMEs, such as low-interest loans, subsidies, secured payments from corporations, and so on.

MSME Registration has been in effect since 2006, and the criteria for classifying a company as an MSME and other provisions have remained unchanged since then.

In light of the current situation, the government has made several amendments to the MSME Act, such as the criteria for categorizing an entity as a small business, the method of calculating turnover and investment for classification, and the process of registration as a small business.

In this article, the impact of revisions to the MSME Act is discussed in detail, including what is the process of changing an entity’s MSME status during the year owing to changes in classification criteria, what procedures should be taken to change status, and the repercussions of not changing status.

Changes to the criteria for classifying businesses as MSME

Different categorization criteria were provided for Manufacturing and Service companies up until June 30, 2021, and classification was also entirely based on the amount of investment made in Plant and machinery.

With effect from July 1, 2021, the distinction between manufacturing and service entities has been eliminated, and a single classification criteria has been established for both types of companies. Furthermore, the classification criteria have been revised to include a new criterion of firm turnover in addition to the amount of investment made in Plant and Machinery or equipment.

What is the process for calculating plant and machinery or equipment investment?

Until June 30, 2021, when calculating the value of an investment in plant and machinery, “Original Cost” was to be regarded, i.e., before depreciation was taken into account. Investment in other machinery, such as tools, jigs, dies, moulds and spares, pollution control equipment, research and development equipment, and so on, was also omitted.

However, as of July 1, 2017, a new technique for calculating investment in plant and machinery has been prescribed:

  1. The Income Tax Act, 1961, will be used to calculate the investment in plant and equipment (P&M). As a result, the net block (after depreciation) of plant and machinery declared in the ITR is regarded to be an investment in plant and machinery.
  2. Given the assumptions used to calculate investment, it can be concluded that investment made up until the end of the previous year should be considered for assessing an enterprise’s status.
  3. In the instance of a new business where no prior year’s income tax return is available, the investment will be based on the promoter’s self-declaration. This self-declaration is valid until the 31st of March of the financial year in which the first ITR is filed.
  4. When calculating the value of plant and machinery or equipment on a self-declaration basis for newly created businesses without an ITR, invoice value excluding GST shall be taken into consideration (Goods and Services Tax).

How to Calculate Turnover for MSME Type Classification

The value of turnover has been included as a new foundation for classifying a business as an MSME. The procedure for calculating turnover is as follows:

  1. Under all GSTINs, the value of turnover will be calculated using information from income tax returns or the Goods and Services Tax (GST) return.
  2. If an enterprise has numerous GSTINs associated with the same PAN (Permanent Account Number), it will be treated as a single entity, and total turnover and investment for all GSTINs will be used to determine whether it is a micro, small, or medium enterprise.
  3. The value of exports of products or services, or both, is not included in the calculation of turnover. As a result, even if a company is primarily engaged in exports, it can still preserve its MSME designation and take advantage of the benefits.
  4. For businesses without a PAN, turnover data will be calculated based on self-declaration for the period ending December 31, 2021. After December 31, 2021, PAN and GSTIN will be required. In the event that the PAN and GSTIN are not available, the MSME registration would be terminated.

What is the impact of a change in an enterprise’s status as a result of altered classification rules?

Changes in categorization criteria, as well as the technique of calculating investment in plant and machinery, may result in a significant shift in an enterprise’s status after July 1, 2021. The procedure for changing an enterprise’s status will be described next:

Unwanted change in the status of the company

If the threshold limit for either of the criteria, i.e., investment in plant and machinery or turnover, increases upward under revised MSME provisions, the status of the enterprise shall be removed from the existing category and placed in the next higher category immediately.

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