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New criteria for classification of MSMEs is good news for the defence sector August, 2018

In a significant move, the Union Cabinet decided in February 2018 to change the basis of categorisation of micro, small and medium enterprises from the quantum of investment in plant and machinery/equipment to annual turnover. Based on the decision of the cabinet, the Ministry of Micro, Small and Medium Enterprises (MSMEs) will move a formal amendment to the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. The cabinet decision will come into effect after the Amendment Bill is passed by the Parliament and assented to by the President of India. This could take several months but there is no reason why the Bill should run into rough weather in the Parliament.

The basis of classification of MSMEs is contained in Section 7 Chapter III of the MSMED Act, 2006 which reads as follows:

7. Classification of enterprises. – (1) Notwithstanding anything contained in Section 11 B of the Industries (Development and Regulation) A ct, 1951 (65 of 1951), the central Government may, for the purpose of this Act, by notification and having regard to the provisions of sub-sections (4) and (5), classify any class or classes of enterprises, whether proprietorship, Hindu undivided family, association of persons, cooperative society, partnership firm, company or undertaking, by whatever name called, –

  1. For enterprises engaged in the manufacture or production of goods pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951 (65 of 1951), as –
    • a micro enterprise, where the investment in plant and machinery does not exceed twenty-five lakh rupees;
    • a small enterprise, where the investment in plant and machinery is more than twenty-five lakh rupees but does not exceed five crore rupees; or
    • a medium enterprise, where the investment in plant and machinery is more than five crore rupees but does not exceed ten crore rupees;
  2. in the case of enterprises engaged in providing or rendering of services, as –
    • a micro enterprise, where the investment in equipment does not exceed ten lakh rupees;
    • a small enterprise, where the investment in equipment is more than ten lakh rupees but does not exceed two crore rupees; or
    • a medium enterprise, where the investment in equipment is more than two crore rupees but does not exceed five crore rupees.

[As per Section 2 of the Industries (Development and Regulation) Act, 1951 (65 of 1951), the First Schedule of the Act contains the list of industries which are controlled by the Union of India. This list includes the defence industry.]

The cabinet has decided to amend Section 7 of the MSED Act, 2006. The amended section will define the enterprises manufacturing goods or rendering services in terms of their turnover. The cut-off for each of the three MSME categories will be as follows:

  1. A micro enterprise will be defined as a unit where the annual turnover does not exceed five crore rupees.
  2. A small enterprise will be defined as a unit where the annual turnover is more than five crore rupees but does not exceed seventy five crore rupees.
  3. A medium enterprise will be defined as a unit where the annual turnover is more than seventy five crore rupees but does not exceed two hundred fifty crore rupees.

These monetary limits may be varied by the Central Government in future through a notification but the revised cap shall not exceed the limits mentioned above by more than three times. The amendment to the MSMED Act, 2006 will contain a provision to this effect, thereby making it easier for the government to change the limits, as and when required, without going through the cumbersome procedure of amending the MSMED Act, 2006.

This change will eliminate the uncertainties inherent in the existing system of classifying the enterprises based on investment in plant and machinery or equipment. The investment figures can be manipulated and, in any case, the existing method of classification provides an edge to the enterprises set up in the earlier years over the ones set up later because of the escalation in the cost of plant, machinery and equipment. Moreover, with the Goods and Services Tax regime in place, it will be easier for the regulatory authorities to make a more accurate and objective assessment of the turnover of an enterprise than the assessment of investment made by an enterprise in plant and machinery or equipment.

The move to amend the MSMED Act, 2006 should have a very positive impact on the enterprises falling in the category of MSMEs. As a matter of fact, the new definition should bring more enterprises within the MSME ambit, irrespective of the cost of plant and machinery, as long as the turnover is within the prescribed limits. This should help the enterprises in the initial stages of their operation to grow by taking advantage of various schemes and incentives meant for this sector. The Ministry of MSME has a number of schemes and so does the National Small Industries Corporation. The details of these schemes are available on their websites.

A mention must be made of the Public Procurement Policy for MSEs Order, 2012 which was notified by the government under Section 11 of the MSMED Act, 2006. This policy, which apparently is not applicable to the medium enterprises and came into force on 01 April 2012, aims at promoting micro and small enterprises by supporting them in marketing their products and services without compromising on the imperatives of competitiveness and sound procurement practices. Some of the salient features of this policy are:

  •  Every procuring entity under the administrative control of the central government shall set an annual target for procurement of 20 per cent of requirement from the MSEs with a sub-target of 4 per cent (out of 20 per cent) for procurement from MSEs owned by the SC/ST entrepreneurs. This has been made mandatory from 01 April 2015.
  • Tenders to be issued to MSEs free of cost and no earnest money to be taken from the enterprises registered as MSEs.
  • MSEs quoting price which is within 15 per cent of the price quoted by the lowest bidder (L1), if such L1 bidder is not from the MSE category, to be allowed to supply 20 per cent of the tendered value at L1 price.
  • Reservation of 358 items for procurement exclusively from the MSEs.
  • Procuring entities to upload their annual requirement on their official websites and also to conduct Vendor Development Programmes or Buyer-Seller meets for MSEs, especially the SC/ST entrepreneurs.

It is not known how the 2012 policy is playing out, especially in defence, but it will not be surprising if the implementation of the policy has not been very smooth, especially in regard to achieving the percentage targets for procurement from the MSEs and the SC/ST entrepreneurs. In any case, the 2012 notification does not seem to have been harmonised with or specifically superseded by the Public Procurement (Preference to Make in India) Order 2017 issued by the Department of Industrial Policy and Promotion (DIPP) on 15 June 2017.

The 2017 order, among other things, provides that an opportunity should be given to a ‘local supplier’ to match the L1 bid, where such bid is from a ‘non-local’ supplier, provided the bid of the local supplier is within 20 per cent of the L1 bid. Subject to the local supplier agreeing to match the L1 price, 50 per cent of the order has to be placed on that supplier if the order is divisible. Where the order is not divisible, the entire order can be placed on the local supplier under these circumstances.

The 2012 and the 2017 orders do not seem to have been incorporated by the Ministry of Defence (MoD) in its capital procurement system. Therefore, change in the basis of classification of MSMEs may not benefit much the MSMEs which are operating in the defence sector and eyeing big capital contracts if one looks at their prospects in the light of these orders. But there are at least two areas in which the change in the basis of classification of MSMEs is likely to have a visible impact in the defence sector. These two areas are Defence Offsets and the Make projects.

With the change in the basis of classification, more enterprises are likely to qualify as MSMEs. Therefore, the foreign suppliers who have to discharge offset obligation will have a wider base of the potential Indian Offset Partners (IOPs) from the MSME sector to choose from. This should help the MSMEs as the foreign suppliers prefer to choose them as IOPs because of the multiplier benefit available to them if they choose MSMEs as their IOPs.

The wider MSME base also improves the prospects of more and more ‘Make’ projects being undertaken by these enterprises as projects with development cost up to Rs 3 crore and Rs 10 crore are reserved under the Make I and Make II sub-categories respectively. Since the Make II category entails self-funding of the cost of prototype development by the industry, the bigger enterprises who may now qualify as MSMEs because of lifting of restriction on investment in plant and machinery and equipment may evince a greater interest in those projects.