GST Composition Scheme – Drawbacks To Be Addressed


The implementation of GST that became effective from 1st July 2017 and the preparatory run up, has had quite a destabilizing impact on small to medium businesses across India. The SME sector that comprises the vast majority of business units that were adversely impacted by the demonetization and hires maximum labor, has been hard hit by GST implementation and witnessed declining revenue and increasing unemployment levels.

With the GST infrastructure and the Infosys maintained common portal, not capable of smoothly handling an unprecedented volume of transactions, the Government’s preparation for a monumental fiscal reform of this magnitude, became questionable. Faced with public outcry and pressure even from within, to mitigate the sufferings of the public, the Government had no option but to adopt various conciliatory measures including shifting the goal post on compliance and return filing deadlines and broadening the ambit of the composition scheme.

GST Composition Scheme is extremely important for easing compliance burden of SME businesses and is an option available mainly to those traders who have a turnover below Rs. 1.5 crore annually. While registering under section 10 of the GST law – Composition scheme aims to provide limited compliance and lower tax rates for small businesses, there are also several drawbacks of registering under the GST Composition Scheme, and that is addressed in this write up.

Major drawbacks of registering under the GST Composition Scheme are as follows:

1.   Imposes state territory limit to do business

A taxpayer registered under the composition scheme is barred from carrying out inter-state transactions nor can he undertake import-export of goods and services. Thus, he is confined to carry out only intra-state transactions and this limits the territory of his business thus contradiction of “One nation One tax” as this section limits the benefit only to the boundary of the state.

2.   Input Tax Credit not permitted

Taxable persons under Composition scheme carrying out business on B2B model, cannot claim input credit from the output liability on B2B transactions. Correspondingly, the buyer of such goods will not get any credit on tax paid, resulting in price distortion and cascading. This will further result in a loss of business as a buyer registered as a normal taxpayer will not get any credit when buying from a person registered under composition scheme. Eventually, such buyers might avoid purchases from a taxpayer under composition scheme.

3.   No collection of Tax from customers

Though the rate of composition tax is kept very nominal at 0.5%, 1%, 2% or 2.5% of turnover [outward supplies] each for the Central Government and the state Government , a taxpayer under composition scheme is not allowed  to recover such tax from his buyer, as he is not allowed to raise a tax invoice.

4.   Value chain broken

Purchasing goods or services from a composition trader breaks the value chain. Consequently, the burden of such tax is kept on the taxpayer himself and this has to be paid out of his own pocket. Thus the fundamental principle of limited compliance and tax burden on small taxpayer is defeated here. In practice, likelihood is that subsequent dealers in B2B will not be able to avail the credit for input taxes and pass on the same to customers, instead of bearing the higher cost of inputs, will inflate prices accordingly, wherever possible. This would end up in the ultimate consumer in B2C transactions incurring higher costs.

5.   Adverse impact of Reverse Charge

Reverse charge is a mechanism where the receipt of taxable services, who buys from unregistered persons, has to pay the GST due on such purchases and remit the same to Governments. Composition traders will end up liable for reverse charge on their purchases, but will not be able to claim input tax credit even on such reverse charge they incurred and paid to Government. This will again increase likelihood the such traders bearing the tax cost unless they increase prices and make the product costlier for the ultimate consumer. In a recent meeting of the GST Council of 6 October 2017, the Government recognizing this anomaly, has given exemption from reverse charge for all intra state purchases from unregistered persons by a registered person till March 2018 and entrusted a Expert panel of studying a less onerous way of reintroducing the same.

6.   Electronic commerce out of scope

One of the major industries which has flourished in recent times, is the e-commerce in India. There have been numerous companies who are into e-commerce, some of them have turnover into crores, however many of them are still at nascent stage and have not achieved breakeven as well. Such units may be carrying out their business online through internet and supply across states. Since they are into inter-state supplies, they are not eligible for composition scheme and thus the benefit of this section has been kept away from them. This is further in contradiction with the government vision of “Digital India” and “Startup India”, which are aimed to promote the startup ecosystem and a digital experience for Indian citizens.

7.   Penal provision to harsh

Another provision applicable to a taxpayer under composition scheme, is being heavily debated As per the GST Law, if the taxpayer who has previously been given registration under composition scheme is found to be not eligible for the composition scheme or if the permission granted earlier was incorrectly granted, then such taxpayer will be liable to pay the differential tax along with a penalty which can extend up to the amount of total tax liability i.e 100%. On analysis of this provision, it appears that if a small taxpayer who has limited knowledge of tax laws and compliance makes any mistake under composition scheme, he shall be liable to pay tax at the standard rate on his total turnover along with a penalty which will be equal to the total tax liability. This level of penal action is quite harsh and needs reconsideration.

Having regard to the above drawbacks, the Government and the GST Council need to seriously reconsider the composition scheme provisions and consider further relaxations, if they really intend to ease the compliance pains of SMEs, who contribute significantly to GDP growth and employment in India.


CA George Kurian | LinkedIn