SME Sector : Legal Overview

    1.1 The Small and Medium Enterprise (‘SME’) sector is the growth engine of the Indian economy. This sector is the fulcrum based on which the Indian economy would leapfrog into the next orbit. It also represents one of the largest employers in the country. As per some estimates, there are more than 12 million SMEs in the country, manufacturing over 8,000 different products and contributing about 9% of the GDP. Further, they also have a 35% share in Indian exports.

    1.2 However, inspite of these statistics, one must also bear in mind that the business mortality rate is also the highest amongst this sector. Hence, it is important that they get adequate support from the Government. Recognising their importance, the Government has enacted various legal provisions to safeguard them. This Article examines the different laws/provisions which deal with the SME sector.

2. MSME Act :

    2.1 The most important step taken was the enactment of the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’). The Act was enacted recognising the need for a comprehensive Act to provide an appropriate legal framework to facilitate the growth and development of the SME sector and to enhance their competitiveness. This Act was officially notified in the Gazette on 18th July 2006.

    2.2 The Act applies to Micro, Small and Medium Enterprises. Before understanding these three definitions, let us understand the meaning of an ‘enterprise’. It means :

•     an industrial undertaking/business concern/other establishment by any other name,

•     which is engaged in the manufacture or production of goods pertaining to an industry specified in the Industries (Development and Regulations) Act; or

•     which is engaged in providing or rendering any service.

    Thus, it can be a manufacturer SME or a service-sector SME. A third type of an SME would not be covered. For instance, would a kirana store (a small-time grocer) be covered under this definition ? In a sector where a vast percentage of the businesses are small-time traders, one wonders why the Act did not think of covering them. There is no definition of the terms service, manufacture and production. Further, the manufacturing activity should only be of those goods which are specified in the First Schedule to the IDRA Act. It is quite strange, that the Act sought to restrict manufacturing only to a limited type of goods and did not think it fit to enlarge the canvass to cover all types of production activity.

    However, the legal form of the enterprise is not relevant, i.e., it could be a sole proprietorship, partnership, LLP, company, HUF, society, AOP, any other legal entity, etc.

    2.3 Under the MSME Act, the Central Government has, vide Notification dated 29th September 2006, classified enterprises as given in table below :

    In calculating the investment in plant and machinery, the Government has notified certain items which should be excluded. Further, in the case of imported machinery, items such as, import duty, shipping charges, customs clearance charges and VAT should be taken into account.

2.6 Disclosure in accounts:

2.6.1 S. 22 of the MSME Act requires every buyer, who is required to get his accounts audited under any law, to furnish the following information in his annual  accounts:

a) The principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of the accounting year.

b) The amount of interest paid by the buyer in terms of S. 18, along with the amounts of the payment made to the supplier beyond the appointed day during each accounting year.

c) The amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day during the year) but without adding the interest specified under this Act.

d) The amount of interest accrued and remaining unpaid at the end of each accounting year.
    
e) The amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/ s.23 of the Act. This clause uses the words small enterprise. Does this mean that payments to a micro enterprise are not covered ‘by this clause?

The penalty for non-compliance is a fine which shall not be less than Rs. 10,000.

3. Schedule VI of Companies Act:

3.1 Schedule VI to the Companies Act, 1956 was also amended by Notification No. GSR 719(E)dated
16-11-2007. Part I dealing with the format of the Balance Sheet requires the following information to be provided under the heading ‘Sundry Creditors’ :

a) total outstanding dues of micro enterprises and small enterprises; and

b) total outstanding dues of creditors other than micro enterprises and small enterprises

3.2 Further, the Schedule also requires the following information (which is also required u/s.22 of the MSME Act) to be disclosed under the Notes  to Accounts  of the Company:

a) the principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of each accounting year;

b) the amount  of interest  paid  by the buyer  in terms of S. 16 of the Micro, Small and Medium Enterprises Development Act, 2006, along with the amount of the payment made to the supplier beyond the appointed day during each accounting year;

c) the amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day dur-ing the year) but without adding the interest specified under the Micro, Small and Medium Enterprises Development Act, 2006;

(d)  the amount  of interest  accrued and remaining unpaid at the end of each accounting year; and

(e) the amount  of further  interest  remaining  due and payable even in the succeeding years, until such date when the interest dues as above are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/s.23 of the Micro, Small and Medium Enterprises Development Act, 2006.

3.3  Saral    Schedule    VI:

3.3.1 The Ministry of Corporate Affairs has issued two drafts of revised Schedule VI for comments, namely Saral Schedule VI for Small and Medium Companies (SMCs) and other for Non Small and Medium Companies. ‘Small and Medium Sized Companies’ (SMCs) are defined in Rule 2(f) of Companies (Accounting Standards) Rules, 2006. SMCs are defined to mean a company which fulfills and satisfies the conditions mentioned here-under as at the end of the relevant reporting period:

i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India;

ii) which is not a bank, financial institution or an insurance c0mpany;

iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding reporting period;

iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding reporting period; and

v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company.

3.3.2 The proposed ‘Saral Schedule VI’ to the Companies Act, 1956has been proposed to take care of the following  needs:

a) make it simple  and  user friendly  for SMCs

b) have minimum  disclosure  requirements

c) ensure that the accounts have compatibility and convergence with IFRS

d) users needs  are limited

4. Income-tax Act :

4.1 5.23 amends the Income-tax Act to provide that the amount of interest payable or paid by any buyer in accordance with the provisions of the Act, would not be allowed as a deduction for computing its income. Thus, in addition to the penal interest payable by the buyer, he will also have to bear the liability to income-tax thereon, as such interest on delayed payments to MSEs (whether already paid or remaining accrued due and payable) will be added to the taxable income of the buyer and subjected to income-tax, year after year, until it is finally paid to the affected supplier. Therefore, the only way for the buyers to avoid such interest and income-tax liability is to pay promptly the supplier’s bills.

4.2 In pursuance of the provisions of the MSMED Act, the CBDT has notified instructions to all assessing officers, vide their Instruction No. 12/2006 dated 14-12-2006, thereby directing them to implement:

a) The provisions u/s.22 of the said Act, which require the aforesaid disclosures, would enable the assessing officers to ascertain the correct amount of disallowance on account of interest payment or paid by the buyer, and

b) S. 23 of said Act lays down that the amount of interest payable or paid by any buyer under or in accordance with the provisions of MSME Act shall not be allowed as deduction in the computation of income.

4.3 Recently, Appendix II, in Form No. 3CD was amended by Notification No. 36/2009, dated 13-4-2009. A new item # 17A has been inserted, which requires the disclosure of the amount of interest inadmissible u/ s.23 of the Micro, Small and Medium Enterprises Development Act, 2006. Thus, by the amendment a duty is now cast also on the auditors of the (buyers) asses sees to reporting of any interest payable to such suppliers and the con-sequential disallowance of the same.

5. Role of CAs:
5.1 Chartered Accountants should bear in mind the requirements under the above laws while auditing the accounts of companies which have dealings with SMEs or which are SMEs themselves (once the Saral Schedule VI) is notified.