A practical analysis- Composition now becomes more attractive

Last week, GST Council decided to make several changes in GST law in respect of small businesses and particularly the composition scheme. Composition scheme is an alternative method of levy of tax on small taxpayers.  Dealers opting for composition are required to pay tax at a fixed rate without ITC benefit. The basic objective of Composition scheme is to reduce compliance cost for small businesses. Let us have a look at the major changes proposed in composition scheme with respect to traders and manufacturers.
  • In GST, different tax rates are prescribed for different goods (0, 5%, 12%, 18%, ) whereas a composition dealer has to pay tax at a single fixed rate. Till now, composition rate applicable to traders was 1% and that for manufacturers was 2%. But now it has been decided to revise the rate for manufacturers also to 1%.
  • The most important change is that previously 1% composition tax was to be paid on total volume of turnover – whether of taxable goods or exempt goods. But now 1% will be applied only on supply of taxable goods and not on exempt goods. For example, a Kirana business sells lot of wheat & rice which is not taxable. Under the revised system, tax of 1% will be charged only on taxable turnover and not on exempt turnover. However, to decide the turnover limit for eligibility under composition scheme, total turnover will be considered. Previously this requirement of paying composition tax even on exempt or tax free goods was proving to be a major reason for dealers not favouring this option. But the situation is likely to change now.
  • GST law is proposed to be changed for increasing the threshold limit for availing composition option to annual aggregate turnover of Rs. 1.5 crore as compared to the present turnover threshold of Rs. 1 crore. After this increase, large number of businesses will become eligible for composition.
In view of these changes, it appears that composition will become much more attractive now. But there are certain points to be kept in mind while deciding about suitability of composition.

  • Dealers engaging in inter-state supply are not eligible for composition option.
  • A composition dealer cannot claim input tax credit on his purchases.
  • If a composition dealer is working on B2B model, his buyers (who are registered as regular dealers) will also not get any credit of tax paid by them which will result in double tax and increase their cost. Hence composition is more suitable for retailers supplying to ultimate consumers who are not bothered about ITC on their purchases.
  • The best way to arrive at proper decision will be to compare the tax impact for the dealer under the two options
Tax liability of the dealer under regular registration can be worked out based on estimates of his turnover of different products or group of products and the gross margin on each product/ group falling under different tax rates. Here the gross margin means difference between the dealer’s purchase prices and sale prices of different goods. For example, if purchase price is 100 and sale price is 115, it means that the margin is 15%. It may also be called as percentage of value addition. Once the above computation is made, the tax amount is to be compared with the dealer’s tax liability if he opts for composition.
Let us examine the matter with some practical examples of retailers who are selling to individual consumers who are not interested in ITC on their purchases. Further, it is assumed that the seller’s gross selling price (including taxes) to the customer will be the same whether he is registered as a regular dealer or a composition dealer. The reason is that it doesn’t matter for the customer whether the dealer is having registration as regular dealer or composition dealer. Hence the nature of registration will not affect the price paid by the customer.
The first example is that of a textile retailer selling different products such as suiting, shirting, sarees and readymade garments. His turnover and margin for different items are estimated as under:
Product
GST rate
Purchase price (Basic)
GST on purchase
Purchase price (incl. tax)
Gross Margin %
Total sale value
Incl. tax
Break-op of sale value
Net GST (after ITC)
Sale
value (Basic)
GST on sale
A
B
C= A x B
D= B + C
E
F= D + E
G
H
I= H – C
Suiting, shirting
5%
1000000
50000
1050000
20%
1260000
1200000
60000
10000
Sarees
5%
1200000
60000
1260000
25%
1575000
1500000
75000
15000
Garments (sale value above Rs. 1000/-)
12%
3500000
420000
3920000
30%
5096000
4550000
546000
126000
5700000
530000
6230000
7931000
7250000
681000
151000
As per above calculation, he will be paying net tax of Rs. 1,51,000 if he goes for registration as a regular dealer and his gross margin  will be Rs. 1550000. If the dealer goes for composition option and sells the goods for the same price of Rs. 7931000, then he will be paying tax of only Rs. 79310 (1% on his turnover) and his margin will increase to Rs. 1621690. Thus, the dealer will be benefitted by going in for composition.
Regular dealerComposition dealer
Total sale value7931000Total sale value7931000
 – Total purchase-6230000 – Total purchase-6230000
 – Net GST (after ITC)-151000 – Composition tax-79310
Margin1550000Margin1621690
Now we take example of another person in a different type of business where regular registration may work out more beneficial over composition. For example, a dealer is having a general store where he sells various types of items falling under GST rates of 5% and 12%. His turnover and margin for different items are estimated as under:
Product
GST rate
Purchase price (Basic)
GST on purchase
Purchase price (incl. tax)
Gross Margin %
Total sale value Incl. tax
Break-op of sale value
Net GST (after ITC)
Sale value (Basic)
GST on sale
ABC= A x BD= B + CEF= D + EGHI= H – C
Items with GST 5%5%2000000100000210000010%2310000220000011000010000
Items with GST 5%5%5500000275000577500015%6641250632500031625041250
Items with GST 12%12%3000003600033600025%420000375000450009000
780000041100082110009371250890000047125060250
Here the dealer will be paying tax of Rs. 60250 under regular option. But under composition option, his tax outgo will be Rs. 93713 (1% on his turnover of Rs. 9371250) and this increase in tax will impact his profit margin adversely. Hence in this case regular registration may be more beneficial than composition option.
Thus it is clear that composition is not suitable for all businesses and it will be better to compare tax liability under both the options before deciding the right option. A business having higher margins or dealing in goods attracting higher GST rates will find composition option more beneficial.  
Here it may be noted that a Composition dealer can come out of the scheme at any time by making an application. Hence the dealer (who is otherwise eligible for composition option) should evaluate pros and cons of composition periodically and if the choice of composition turns out to be wrong, he can change his decision.

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