Does Composite levy under GST compensate SMEs for loss of exemptions?

As per current indirect tax laws, SMEs claim an exemption from Excise duty under following conditions:

• Manufacturers – If the turnover is less than Rs. 1.5 Crore
• Traders – As Excise duty is a tax on manufacturing, traders can choose to opt out regardless of the turnover. If they choose to opt-in, they can pass on the Excise in their invoices to the extent of input taken (traders don’t have to charge Excise duty for the value added)

This exemption will go away with the rollout of GST and all taxpayers will be subject to a uniform tax, i.e, GST. To ease the burden of GST compliance on small manufacturers and traders, GST Draft Law provides an optional scheme known as Composition levy.

What is Composition Scheme under GST ?

It is a scheme under the GST regime wherein eligible taxpayers can choose to pay a lumpsum tax based on turnover. It is an optional scheme –Taxpayer has the option to choose or not

Who is eligible to opt for Composition Scheme ?

Aggregate turnover of the person having same PAN during the previous financial year not exceeding Rs 75 lakhs.

Conditions for a Composite Tax Payer

Taxpayer if eligible based on turnover should also adhere to the following conditions

• Taxpayer cannot be engaged in supply of services
• Cannot be engaged in manufacture of specific notified goods
• Cannot supply goods not taxable under GST
• No Interstate supplies are allowed under the scheme
• Cannot claim Input Tax Credit on inward supply of goods and / or services
• Cannot collect tax on outward supply of goods and / or services
• Applicable for all business verticals under the same PAN – Composition levy will be applicable for all business verticals operating within state or interstate under the same pan.
• If the composite tax payer is in the trade of supplying goods and services, then composition levy will be applicable for both supply of goods and supply of services.
• Cannot supply goods through an e-commerce operator
• Tax payable under reverse charge mechanism would still be payable
• Permission of proper officer of the central or state government is required for adopting this Scheme. This clause is particularly discretionary and may result in usual problems associated with bureaucracy.

Rate of Levy under the Composition scheme

• Manufacturer –2 % of turnover
• Traders – 1% of turnover
• Restaurants – 5% of turnover

Benefits of Composition scheme

Given all the conditions and restrictions, are there any compelling benefits of the scheme? The main perceived benefits are

• Ease of Accounting burden – Have an option of not having to maintain detailed records or follow tax invoicing rules
• Simplicity – Pay taxes at a fixed rate as a percentage of turnover
• Easier compliance norms – file GST returns quarterly instead of monthly

Return Forms for a Composite Tax Payer

A composite tax payer is required to file quarterly return and annual return. Types of returns and details to be furnished are explained below

Composition Scheme Example :

Lets consider a Samsung mobile phone with MRP for Rs.20,000.

The flow of product is as follows :

Step 1 – Manufactured by Samsung and sold to distributor – Coral Fabtech – for Rs.12000

Step 2 – Coral Fabtech sells it to retailer -Sangeetha Mobiles for Rs. 14000

Step 3 – Sangeetha Mobiles sells the phone to consumer for Rs. 20000

Assumptions

• GST Rate is presumed at 20% for simplicity
• Composition Levy presumed at 2% on turnover
• MRP is fixed and a retail sale must take place at MRP or less as per law.
• Composition dealer neither collects tax from recipient nor is eligible for an Input tax credit

The following scenarios are possible :

Scenario 1

This is the base case when none of the taxpayers opt-in for the Composite scheme. The results of other scenarios would be compared to this base case to determine if the scheme is beneficial.

Total Profit of Supply Chain                =          Rs. 6667

Total Tax Revenue for Government    =          Rs. 1333

Scenario 2

This is a scenario where intermediate taxpayer in the supply chain opts for Composition scheme and hence the GST credit chain is broken.

Total Profit of Supply Chain                =          Rs. 3939

Total Tax Revenue for Government    =          Rs. 4061

*Sale price to keep margin constant at Rs.2000

Scenario 3

This is a scenario where once a taxpayer in the supply chain opts for Composition scheme all taxpayers down the supply chain opt for composite scheme.

Total Profit of Supply Chain                =          Rs. 6872

Total Tax Revenue for Government    =          Rs. 1128

Scenario 4

This is a similar to scenario 3 , difference being that  only the last taxpayer who sells B2C i.e, directly to consumer, opts for Composition scheme.

Total Profit of Supply Chain                =          Rs. 6800

Total Tax Revenue for Government    =          Rs. 1200

Conclusion

As evident from the above analysis, it is clear that once a supplier opts for Composition scheme, the GST credit chain is broken and resumption of GST by the supply chain results in increased tax liability, therefore the scheme is best suitable for B2C businesses. Further, whether it is profitable to opt for Regular GST scheme or Composite scheme is governed by GST rate, Composite Levy rate and value addition at each stage (margins). In the above example the margins were high at each stage- 15-20% approx. and composition levy was low at 2%.

Lower margins or increased number of middlemen will have an adverse effect on the  benefits of composition scheme.

Feel free to reach out to us at support@gstsmadhaan.com for in-depth analysis and appropriate GST strategy for your business.

Prakash Agarwal

Author is an IIT, IIM graduate with many years of experience in finance and SME sector.