Composition Scheme – Impact on SMEs

Pramit Pratim Ghosh |Updated on: January 10, 2022

The heart of the Indian economy is its small and medium business segment. As on today we have about 50 million SMEs in India - contributing almost 37% of the industrial output and 46% of India’s total export. With a stable growth rate of over 10%, SME India employs a staggering 120 million people and has emerged as the leading employment-generating sector, over the years. It goes without saying, that when the nation is on the verge of a massive taxation regime change in the form of GST - its impact on the life of SMEs is super critical for the nation as a whole.

At the 22^nd GST Council meeting on the 6^th of October, 2017 – the turnover limit for composition scheme was recommended to be increased from the current INR 50 lakhs to INR 75 lakhs for special category states except Uttarakhand (Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, and Himachal Pradesh) and for rest of India, it was increased from INR 75 lakhs to INR 1 crore. In light of this recent development, let’s revisit the impact the composition provision will have on the many SMEs – both those who have been under composition in the current regime and will continue to remain so under GST; and especially those, who were looking to getting registered, but now suddenly have an option to take the composition scheme – thanks to the increase of INR 25 lakhs in the limit.

Pros

Increased threshold limit

In the current regime, the exit threshold for composition scheme across most states is INR 50 lakhs. Under GST, this limit, although initially kept at INR 50 lakhs has now been increased to INR 75 lakhs (Special Category States except Uttarakhand  -Himachal Pradesh, Sikkim and the 7 NE states ). For rest of india, it has now been increased from INR 75 lakhs to 1 crore.  It is obvious, that this will make more number of SMEs eligible to take the benefit of the composition scheme.

Lower rate of tax

Compared to dealers, who are liable to register, a composite dealer will enjoy the main benefit of paying a comparatively lower rate of tax. The rate of tax has been fixed at – 2% for a manufacturer, 1% for a trader and 5% for small restaurants – engaged in supplies of food and drinks for human consumption.

Lesser compliance activity

Compared to registered dealers, a composite dealer will be spared the brunt of 3 monthly returns – rather he will be required to file 1 quarterly return, every 3 months and 1 annual return. This will surely save a lot of time for a composite dealer, allowing him to focus on core business activities which are crucial to keep him afloat in the market.

Cons

Restrictions on nature of goods & services

A composite dealer cannot be engaged in the manufacture of certain notified goods, which would be specified by the Government and the GST Council. While we await more clarity on the same, the restriction in terms of services is pretty clear – a composite tax payer cannot be engaged in any service other than the supply of food and drinks for human consumption – in other words, a small restaurant is the maximum, a composition dealer can think of setting up. Also, a composite tax payer cannot supply goods outside the ambit of GST.

Restrictions on mode of trade

A composite dealer, as per the GST law, cannot engage in trade on e-commerce platforms and also, cannot engage in interstate outward supplies of goods or services. In other words, SMEs who would want to transcend their horizons by going the online way and would want to serve customers in other states, will not have the option to enjoy the composition scheme, irrespective of turnover.

No ‘selective’ composition scheme

In the current registration system, there is a standard practice of multiple business verticals and establishments with multiple registrations – which allowed the possibility of the composition scheme being availed for selected businesses. But under GST, registration will be PAN based. Most importantly, composition scheme will be applicable for all business verticals – within state or interstate – registered with the same PAN. Thus, an SME may have different business verticals that too, spread across several states – but will not be able to select specific verticals and/or branches for composition scheme. What it also means is – A registered person with a single PAN of operations in multiple states, has to either opt for “Composition scheme” for all businesses across the country, or opt for regular dealership.

No tax collection, no ITC

A composite dealer does not have to collect tax on his outwards supplies of good or services. But, most importantly, the composite tax payer is not eligible to claim input tax credit on all his inward supply of goods and / or services – even if he makes a taxable purchase from a regular taxable dealer. As a result, the taxable amount gets added to the cost of the composite dealer, ultimately increasing the cost for his customers. This is bound to take a toll on his competitiveness, in comparison to regular dealers.

More depth in compliance

In the current composition scheme, a composite dealer has to declare only the aggregate turnover of sales; he is not required to declare invoice wise details. In GST however, the composite tax payer will need to file GST returns with the invoice wise details of inward supplies (which is auto-populated based on Form GSTR-1 filed by his supplier) along with the aggregate turnover of outward supplies. Thus, this will require an SME under composition scheme to maintain his accounting and transaction records properly.

Conclusion

On the face of it, it may not be a good idea for an SME to opt for composition, even though it means increased compliance, because it could translate to greater business benefits in the long run. However, if an SME is purely into B2C business, the composition rate is low and the net margins are higher, composition may turn out to be a viable option.