Understanding the Limitations of the GST Composition Scheme

The Goods and Services Tax (GST) Composition Scheme offers a simplified tax compliance option for small businesses with an annual turnover below a certain threshold. While it presents advantages, it also comes with specific disadvantages. This article will explore these limitations. It is important to note that the Central Board of Indirect Taxes and Customs (CBIC) increased the turnover limit from INR 1.0 crore to INR 1.5 crores, effective from February 1, 2019. Previously, we discussed the benefits of opting for the Composition Scheme under Section 10 of the GST law, which provides reduced compliance burdens and lower tax rates for eligible small taxpayers. (Read our previous article).

Key Disadvantages of the GST Composition Scheme

Limited Business Territory

Businesses operating under the Composition Scheme are restricted from engaging in inter-state sales, as well as import and export activities involving goods and services. This regulation confines their operations strictly to intra-state transactions, significantly limiting their market reach and business expansion opportunities within national borders.

No Input Tax Credit

A significant drawback is the inability to claim input tax credit (ITC) on business-to-business (B2B) transactions. This means that a taxpayer under the Composition Scheme cannot offset the GST paid on their inputs against their output tax liability. Furthermore, buyers who are registered as regular taxpayers will not receive any ITC when purchasing from a composition dealer. This can lead to increased costs, price distortions, and a cascading tax effect, potentially discouraging normal taxpayers from sourcing goods or services from businesses under the Composition Scheme.

Inability to Collect Tax

Even with the Composition Scheme's low tax rates (typically 1% or 5%), taxpayers cannot issue a tax invoice or collect this tax from their customers. Instead, the tax burden falls directly on the business owner, who must pay it out of their own revenue. This aspect undermines the scheme's core objective of simplifying compliance and reducing the tax load for small taxpayers.

Penalties for Ineligibility

The scheme includes stringent penal provisions. If a taxpayer granted Composition Scheme registration is later found ineligible, or if the initial permission was erroneously approved, they become liable to pay the standard differential tax. Additionally, a penalty up to 100% of the total tax liability can be imposed. This provision means that a small taxpayer, who might have limited understanding of complex tax regulations, could face substantial financial repercussions for any inadvertent errors, potentially being required to pay tax at normal rates on their entire turnover plus a matching penalty.

Exclusion of E-commerce Businesses

Businesses engaged in electronic commerce are generally excluded from the Composition Scheme. Given that e-commerce platforms often facilitate inter-state supplies, these entities—even nascent startups with lower turnovers—are deemed ineligible. This exclusion seemingly conflicts with national initiatives like 'Digital India' and 'Startup India,' which aim to foster digital growth and support new businesses, by denying a simplified tax option to a rapidly expanding sector.

While the Composition Scheme is designed to ease compliance for small taxpayers, its existing limitations necessitate careful consideration. Businesses must thoroughly evaluate these drawbacks before opting for registration under the scheme to ensure it aligns with their operational model and future growth plans.