The Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) defines how businesses in India qualify as MSMEs, register and access legal protections, particularly in relation to payments and compliance.
It applies to both manufacturing and service enterprises under the revised classification introduced in 2020. The Act covers enterprise classification (Section 7), the National Board (Sections 3-6), payment liabilities (Sections 15-19), Facilitation Councils (Sections 20-21), reporting (Section 22), penalties (Section 27) and information disclosure (Section 26).
Under Sections 15 to 24 of the MSMED Act, buyers must make timely payments to micro and small enterprise (MSE) suppliers. The framework has been strengthened through amendments, including the 2020 update that introduced combined investment and turnover criteria and removed the distinction between manufacturing and service enterprises. Credit support outside the Act, such as collateral-free lending under schemes like CGTMSE, has also been expanded.
Enterprise classification in the MSME Act
Under the Act, businesses are classified as micro, small or medium enterprises based on their investment in plant and machinery or equipment and their annual turnover. This combined criterion was introduced in 2020 and revised in 2025, and applies to both manufacturing and service enterprises.
Current classification (as applicable in 2026):
- Micro: Investment ≤ ₹2.5 crore and turnover ≤ ₹10 crore
- Small: Investment ≤ ₹25 crore and turnover ≤ ₹100 crore
- Medium: Investment ≤ ₹125 crore and turnover ≤ ₹500 crore
During registration, businesses report their investment and turnover through PAN- and GST-linked systems. Classification is determined using data from income tax and GST returns.
For classification, turnover excludes export turnover and investment is calculated based on income tax records (written down value of assets).
If a business exceeds the prescribed investment or turnover limits, its classification is revised to the next category based on updated financial data, as per government rules.
What is the Udyam registration?
Businesses that want to be recognised as MSMEs must register on the Udyam registration portal.
The process is fully online and integrated with Aadhaar, PAN and Goods and Services Tax (GST) systems, which verify business information.
Key features of Udyam registration:
- Free and online registration process
- Aadhaar-based verification
- Automatic PAN and GST data retrieval
- Issuance of a digital registration certificate
Upon registration, businesses receive a Udyam registration certificate confirming their MSME status. They need to update their registration details if there are significant changes.
An unregistered business may lose protections under the Act, such as the right to claim interest on delayed payments.
Late payment policy for customers
The MSMED Act includes provisions to protect payments to MSME suppliers. Buyers must pay MSME suppliers within the agreed contractual period. However, the payment period cannot exceed 45 days from the date of acceptance of goods or services.
Interest on overdue payment
If payment is made after the stipulated period, the buyer must pay compound interest at three times the RBI-notified bank rate. This interest is calculated from the day of default, which is the day after the payment due date.
This interest is defined under Section 16 of the MSMED Act and is enforced through claims or proceedings, such as before the Micro and Small Enterprises Facilitation Council (MSEFC). It requires action by the supplier.
Mediation in the MSME Act
The MSMED Act, 2006 provides a formal mechanism to resolve payment disputes between micro and small enterprises and buyers under Sections 15–18.
States and Union Territories establish one or more Micro and Small Enterprises Facilitation Councils (MSEFCs) to handle these disputes.
The dispute resolution process involves:
- Filing a reference with the MSEFC
- Conciliation between the parties under the Arbitration and Conciliation Act, 1996
- Arbitration, if conciliation fails, conducted by the Council or referred to an institution
- Issuance of an arbitral award
Under Section 19 of the MSMED Act, an appeal against the award must be filed within 90 days. It also requires a mandatory deposit of 75% of the award amount.
Important compliance requirements for businesses
Companies dealing with MSME suppliers must comply with disclosure requirements under Section 22 of the MSMED Act, 2006. They need to report in their annual financial statements the principal amount and interest due to MSME suppliers for delayed payments.
Non-disclosure of this information attracts penalties under Section 27 of the MSMED Act. In such cases, the buyer is liable to a fine of not less than ₹10,000.
MSME-1 filing requirement
When a company does not pay MSME suppliers within 45 days, it must file MSME-1 returns with the Ministry of Corporate Affairs. These returns are filed twice a year.
MSME-1 filing is required only where payments to MSMEs remain outstanding beyond 45 days. Nil returns are generally not required under current MCA practice.
Non-compliance can result in:
- Company fines of up to ₹25,000
- Penalties for officers of up to ₹3 lakh
- Imprisonment of up to 6 months in serious cases
These penalties arise under Section 405 of the Companies Act, 2013, and not directly under the MSMED Act.
Reporting to government officials
Section 26 of the Act requires businesses to disclose information requested by authorised government officers. Failure to provide this information may result in penalties ranging from ₹1,000 to ₹10,000.
The Samadhaan portal allows businesses to track cases related to MSME payment disputes and monitor delayed payment complaints.
Recent changes that impact the compliance of MSMEs
The MSME framework has been updated through several regulatory changes:
Updated criteria of classification (2020)
The government introduced a combined investment and turnover-based classification system, removing the earlier distinction between manufacturing and service enterprises.
Retention of non-tax benefits (2020 notification)
If a business moves to a higher MSME category due to growth, it may continue to receive certain non-tax benefits of the previous category for up to three years, subject to scheme-specific conditions.
Section 43B(h) amendment (2023)
A key change linked to MSME payments was introduced under the Income Tax Act.
Under Section 43B(h), payments to registered MSME suppliers must follow the prescribed timelines:
- Within 15 days where no written agreement exists
- Within a maximum of 45 days where a written agreement exists
If payments are not made within these timelines, the expense cannot be claimed as a tax deduction until the payment is made.
Measures to comply with the MSME Act
Businesses can follow several practical steps to remain compliant with the Act:
- Review eligibility under MSME classification limits periodically (based on investment and turnover criteria).
- Register or update details on the Udyam portal in a timely manner.
- Maintain separate accounting records for MSME suppliers to track dues accurately.
- Ensure payments to MSME vendors are made within the prescribed timelines.
- File MSME-1 returns where applicable, within due dates.
- Disclose outstanding MSME dues (arrears) in financial statements as required.
- Approach the Micro and Small Enterprises Facilitation Council in case of payment disputes.
Conclusion
The MSME Act provides the legal structure that supports small and medium enterprises in India. It defines enterprise classification and establishes payment protection rules, including mechanisms for dispute resolution.
Understanding the provisions of the Act helps business owners operate within the legal framework and access government benefits. By maintaining proper financial records and using reliable accounting systems such as TallyPrime, businesses can simplify compliance while continuing to focus on growth.
