Navigating the revised criteria for Micro, Small and Medium Enterprise (MSME) classification

Navigating the revised criteria for Micro, Small and Medium Enterprise (MSME) classification

As part of its strategy to promote growth and resilience of the Micro, Small and Medium Enterprises (MSMEs), the Government of India (GOI) has introduced two key regulatory changes impacting entities that purchase goods or services from the MSMEs (the buyer). These changes relate to:

• Revised criteria for classification of MSMEs
• Half yearly reporting under MSME-1 of overdue MSME payments to the Ministry of Corporate Affairs (MCA)

Revised criteria for classification of MSMEs

The Micro, Small and Medium Enterprises Development Act, 2006 (MSME Act) prescribes investment and turnover criteria for classification of MSMEs. It requires that for an entity to be classified as MSME, both investment in plant and machinery as well as turnover should be within the prescribed thresholds, i.e., both criteria must be satisfied concurrently. If the entity fails to meet even one criterion, it will be disqualified from the MSME classification.

Pursuant to the notification dated 21 March 2025 issued by the Ministry of Micro, Small and Medium Enterprises, Government of India, the investment and turnover criteria for classification of MSMEs as prescribed under the MSME Act have been changed. Given below are the changes made in the criteria:

Hence, pursuant to the amendment, both the investment in plant & machinery as well as turnover thresholds have significantly increased implying that a relatively higher number of entities will now be classified as MSMEs.

The notification enhancing the limits comes into force with effect from 1 April 2025 (subject to practical challenges discussed below).

Reporting of overdue MSME payments to the Ministry of Corporate Affairs

The Government of India, vide its notification dated 25 March 2025, has directed all companies, that purchase goods or services from micro or small enterprises and whose payments get delayed 45 days from the date of acceptance/ deemed acceptance of goods or services, to submit a half yearly return (MSME-1) to the Ministry of Corporate Affairs (MCA) stating the following:

• The amounts of payments due, and
• The reasons for the delay.

As this appears to be a reiteration of an existing requirement under notification dated 2 November 2018, no separate effective date has been specified in the recent notification.

Relevance of the above changes for entities dealing with MSMEs

Among other matters, the MSME Act requires the following:

• The entity that purchases goods or services from MSMEs (the buyer) must make payment for the goods or services on or before the date agreed between the parties in writing. In case no specified date is agreed, then the payment needs to be made before the appointed day. The appointed day means the day after the expiry of 15 days from the date of acceptance or deemed acceptance of goods or services by the buyer.
• In any case, the agreed payment period between the seller and the buyer cannot exceed 45 days from the date of acceptance or deemed acceptance of goods or services. Hence, the MSME Act requires the buyer to make payment to the MSME supplier within a maximum period of 45 days.
• If the buyer fails to make payment to the supplier within the prescribed period, the buyer will be liable to pay non- tax deductible compounded interest to the supplier for the period of delay at the rate which will be three times of the bank rate notified by the Reserve Bank of India.

Further, Section 43B(h) of the Income-tax Act, 1961 (as amended by Finance Act, 2023) triggers disallowance if payments to a “micro” or “small” enterprise are delayed beyond the time limit specified under the MSME Act and allows it in the year of actual payment. Unlike other items covered by Section 43B, the extended date of actual payment until the due date of filing the return is not available for payments to “micro” or “small” enterprises. The enhancement of turnover/investment limits for enterprises to qualify as “micro” or “small” under the MSME Act has a consequential impact of expanding the scope of disallowance under Income- tax Act to more vendors.

Way forward for companies dealing with MSMEs

Considering the above, it is clear that entities purchasing goods or services from MSMEs (the buyer) have the responsibility for ensuring compliance with the specific requirements of the MSME Act. Any non-compliance with the 45-day payment requirement may have financial and tax implications, trigger reporting to the MCA and may also potentially expose entities to regulatory scrutiny and reputational risks. Hence, it is imperative that entities prepare themselves for dealing with the requirements of the MSME Act and requirements for reporting information to the MCA, considering the revised thresholds notified under the MSME Act. Toward this, the entities should consider the following actions:

• Pursuant to the revised thresholds, many current suppliers may get classified as MSMEs. Entities should initiate confirmations with their vendor base to identify suppliers that will get covered under the MSME Act, pursuant to the revised thresholds.
• A one-time exercise may be required to collect updated/ revised MSME declarations and to make system changes to track and highlight MSME status basis the revised thresholds.
• Entities may need to revisit their contracts with newly classified MSMEs, to ensure that they comply with the MSME Act requirements. Particularly, clauses related to payment and interest in case of delay may need to be revisited.

Practical challenges

The application of the above notification also gives rise to certain practical challenges. Given below is an overview of these challenges and our perspective. Since these matters involve legal interpretation, it is imperative that entities clarify these matters with legal professionals:

• It is stated that the notification related to the revised criteria for classification of MSMEs is applicable from 1 April 2025. However, it is not clear whether the revision will apply only to amounts payable to the MSMEs arising from new purchase/ sale transactions entered into after the effective date or if it will also apply to amounts payable to the MSMEs arising from purchase/ sale transactions entered into before the effective date and having an outstanding balance at the reporting date
  
  While the matter has not been specifically clarified, one may argue that payment terms are negotiated and agreed upon at the time of entering into the transaction. Assume that a supplier was non-MSME at the time of entering into purchase/ sale transaction and, consequently, it agreed to payment terms which are longer than 45 days. Since the supplier entered into this transaction being a non-MSME entity, it may be argued that its payment terms should not be impacted by subsequent change in the status of the MSME entity at a later date. Hence, the revision will apply only to amounts payable to the MSMEs arising from new purchase/ sale transactions entered into after the effective date. We recommend that this matter involves legal interpretation and entities should confirm view with legal professionals.
• Attention is invited to the notification dated 26 June 2020 issued by the Ministry of Micro, Small and Medium Enterprises (the ‘old notification’). The old notification has not been withdrawn and is, therefore, still in force. Paragraph 8(6) of the old notification states that “In case of reverse-graduation of an enterprise, whether as a result of reclassification or due to actual changes in investment in plant and machinery or equipment or turnover or both, and whether the enterprise is registered under the MSME Act or not, the enterprise will continue in its present category till the closure of the financial year and it will be given the benefit of the changed status only with effect from 1st April of the financial year following the year in which such change took place.” Considering the old notification read with the notification dated 21 March 2025, an issue arises whether the effective date of change in classification should be 1 April 2025 or 1 April 2026 under the MSME Act 2006?
  
  To support a change in classification from 1 April 2025, one may argue that the phrase ‘following the year in which such change took place’ in paragraph 8(6) of the old notification does not refer to the effective date of the new notification (i.e., 1 April 2025); rather, it refers to the year in which the new notification was issued (i.e., 21 March 2025). Thus, on application of paragraph 8(6) of the old notification, the revised limits take effect from 1 April 2025. To support this one may also argue that since a specific application date is prescribed in the new notification, the old notification is not even relevant. Thus, the revised classification criteria apply from 1 April 2025
  
  To support a change in classification from 1 April 2026, one may argue that the phrase ‘following the year in which such change took place’ refers to the effective date of the new notification (1 April 2025). On application of paragraph 8(6) of the old notification, the revised limits will take effect from 1 April 2026. This view is further supported by the Delhi High Court decision in case of The Mining and Engineering Corporation v Union of India [W.P.(C) 5612/2020], wherein the Delhi High Court held that the earlier notification dated 1 June 2020 was superseded by the old notification dated 26 June 2020 and the benefit of revised classification is available from 1 April 2021 only.
  
  We recommend that the Ministry of Micro, Small and Medium Enterprises may consider clarifying this matter. Until the matter is clarified, the entities should consult their legal professionals to arrive at an appropriate legal position.
• With regard to the notification requiring reporting of overdue MSME payments to the Ministry of Corporate Affairs, no application date has been specified. It may be noted that in the past also a similar notification³ was issued for filing half-yearly returns under MSME-1 for outstanding MSME dues, without mention of an effective date. This seems to suggest that these requirements are applicable with immediate effect. The reporting will be required for entities covered under the MSME classification based on the criteria applicable at each reporting date.

How we see it

We believe that the government’s revised MSME classification criteria and new reporting requirement are part of its broader push to drive payment discipline and strengthen financial health of the MSME sector. The entities involved or likely involved in purchase of goods or services from MSMEs should evaluate legal/ interpretation issues and prepare themselves for complying with the new requirements. This will require a one-time as well as ongoing effort, including updates to the systems and processes.

We also recommend that the Ministry of Micro, Small and Medium Enterprises may consider providing appropriate clarification on issues involved so that better consistency can be ensured in the implementation.