GST Composition Scheme: Simplified Taxation or a Hidden Revenue Generator?

[Aratrik Banerjee]

The introduction of the Goods and Services Tax (GST) in India was primarily aimed at streamlining indirect taxation and reducing compliance burdens for taxpayers. A significant component of this initiative is the Composition Scheme, which is ostensibly designed to provide relief to small businesses. However, the scheme raises important questions regarding its true efficacy. Does it genuinely serve the interests of small businesses, or does it merely function as a structured mechanism to ensure tax collection from this sector with limited reciprocal benefits? This article undertakes a critical evaluation of the Composition Scheme, particularly through the lens of tax litigation.

Understanding the Composition Scheme

The Composition Scheme under GST is tailored for small taxpayers with an annual turnover of up to ₹1.5 crore (₹75 lakh for specific states). It allows them to discharge tax liability at a fixed percentage of their turnover rather than adhering to standard GST rates. The prescribed rates vary across industries:

• Manufacturers and traders: 1%
• Restaurants (excluding those serving alcohol): 5%
• Service providers (introduced in 2019): 6%

However, taxpayers opting for this scheme face significant restrictions—they cannot issue tax invoices that enable Input Tax Credit (ITC) for buyers, nor can they engage in interstate trade.

Perceived Advantages of the Composition Scheme

1. Simplified Compliance: One of the principal advantages is reduced compliance obligations, as businesses are required to file quarterly returns instead of monthly filings under the regular GST regime.
2. Lower Tax Liability: The concessional tax rate serves as a relief for small enterprises that may struggle with the higher GST rates applicable to standard taxpayers.
3. Minimal Documentation: Unlike the intricate record-keeping requirements of the regular GST system, businesses under this scheme benefit from relatively relaxed documentation norms, making it particularly advantageous for enterprises with constrained resources.

Critical Drawbacks: A Deeper Analysis

1. Denial of Input Tax Credit: The foremost drawback is the prohibition on claiming ITC. This renders the scheme less viable for businesses with substantial input costs, as they end up paying tax on inputs as well as on turnover without any set-off benefits.
2. Restricted Market Expansion: Composition taxpayers are barred from engaging in interstate trade, significantly curtailing their growth potential. This restriction is particularly detrimental for businesses located in border regions or those aspiring to expand beyond their local jurisdiction.
3. Tax Cascading Effect: Since composition dealers cannot issue tax invoices with ITC eligibility, their buyers are unable to claim ITC on purchases. This makes goods and services procured from such businesses relatively costlier compared to those sourced from regular GST taxpayers.
4. Taxation on Turnover, Not Profit: A fundamental flaw of the scheme is that tax is levied on turnover rather than profits. Consequently, even businesses operating at a loss or with thin margins must discharge tax liabilities, exacerbating their financial strain.
5. Compliance Burden Not Entirely Eliminated: While compliance is relatively relaxed, businesses must still adhere to periodic return filings and basic record-keeping. Additionally, transaction-based restrictions often create indirect operational complexities.

Composition Scheme: A Revenue-Driven Mechanism Rather Than a Genuine Relief Measure?

At the heart of the ongoing debate lies a fundamental question that captivates both entrepreneurs and policymakers alike—does the Composition Scheme genuinely empower small businesses, or is it simply a cleverly disguised mechanism aimed at boosting revenue? When we peel back the layers, the scheme reveals itself as a complex double-edged sword that seems designed to secure a steady stream of tax revenue from small enterprises, while simultaneously hindering their ability to compete in a fast-paced market.

Consider this: for many small business owners, the denial of Input Tax Credit (ITC) feels like a heavy weight on their shoulders. It limits their competitiveness, as they struggle to offer prices that can rival those of their regular GST-registered counterparts who benefit from ITC perks. As a result, small businesses often find themselves squeezed out of the market, unable to compete against those who can lower their prices thanks to these advantages.

In essence, the promised relief of a lower tax rate under the Composition Scheme sometimes morphs into an illusion, trapping small enterprises in a cycle of increased effective tax burdens rather than freeing them from financial constraints. This situation begs the question: is this scheme really the lifeline it claims to be, or merely a mirage in the desert of economic struggle faced by small businesses?

Navigating this terrain requires a sharp business acumen and a keen understanding of the market ecosystem, as small entrepreneurs strive to find their footing amidst the complexities of the taxation landscape.  The stakes are high, and the future of many small businesses hangs in the balance—a riveting drama playing out in the world of commerce.

Conclusion

The Composition Scheme was designed to simplify tax compliance for small businesses, but its restrictions often overshadow its intended benefits. While it aims to reduce the regulatory burden, the denial of Input Tax Credit (ITC), constraints on market access, and reliance on turnover-based taxation can make it less appealing for many enterprises.

Instead of serving as a supportive framework, the scheme often seems more focused on ensuring tax revenue from small businesses than genuinely addressing their financial and operational challenges. This raises a critical question: how can we make the scheme more beneficial for these vital players in the economy?

To enhance its effectiveness, policymakers might explore adjustments such as allowing limited ITC claims, which would provide small businesses with greater financial flexibility. Additionally, enabling controlled interstate trade could open new avenues for growth and expansion, thereby ensuring that the scheme not only facilitates tax collection but also supports the sustainable development of small enterprises. By revamping the Composition Scheme, we could create a more inclusive and supportive environment for small businesses, fostering innovation and economic growth in the long run.