Composition Option – A Tax Planning Tool For Small Businesses

Recently GST Council has decided to make several changes in the GST law in respect of small businessmen and particularly the composition scheme. Small businesses were facing severe problems in complying with the existing GST provisions which are now made simpler. In view of the changed situation, it has become necessary to look at composition scheme afresh.

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 and the basic objective of Composition scheme is to reduce compliance cost for small businesses. As per the present rules, person doing supplies only within the same state can opt for composition. Composition tax rate for traders is 1% and for manufactures 2%. In case of restaurants it is 5%. Some manufacturers are not eligible to opt for composition (like ice-cream, pan masala, tobacco products).

Previously, less compliance (regarding billing, record keeping, returns, etc.) was a major factor in favour of composition. However, now that the returns to be filed by small taxpayers have also been made quarterly instead of monthly, this aspect of less compliance is not much relevant for choosing between regular and composition options by small businessmen.

Let us have a look at the major changes proposed in composition:

1. Increase in threshold limit: The threshold limit for availing composition option has been increased to annual aggregate turnover up to Rs. 1 crore as compared to the earlier turnover threshold of Rs. 75 lacs. Similarly threshold for special category states has been increased from Rs. 50 lakhs to Rs. 75 lacs. This will make it possible for more number of taxpayers to avail the benefit of composition scheme.

2. Monthly choice: The option of availing composition as per the increased threshold shall be available to all eligible taxpayers (both migrated and new taxpayers) up to 31st March, 2018. Previously this was available up to 30th Sept, 2017. The option shall become operational from the month succeeding the month in which the option is exercised.

3. Exempt services eligible: Previously, dealers providing any exempt service were being considered ineligible for composition scheme. Now such persons who are otherwise eligible for availing the composition scheme and are providing any exempt service, shall be eligible for composition scheme.

4. RCM put on hold: Compliance with Reverse charge mechanism under section 9 (4) of CGST Act was proving very difficult for small businesses. The same has been suspended till 31.03.2018 and will be reviewed by a committee of experts.

5. GOM: A Group of Ministers is being constituted to examine measures to make composition scheme more attractive.

No doubt composition scheme is quite simple, but it may not necessarily be suitable for all persons below Rs. 1 crore turnover. The main factors to be considered in this decision as summarised below:

• Nature of business: Composition dealer cannot claim input tax credit even if he makes taxable purchases from a regular registered dealer. Moreover, 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 which will increase their cost. Hence such buyers will naturally avoid purchases from a composition dealer. Broadly, it can be said that composition is more suitable for retailers supplying to ultimate consumers who are not bothered about ITC on their purchases.

• Tax cost impact comparison: The advantage of having a single rate in case of a composition dealer is that he need not worry about taxability/ tax rates for each product. But there is also a disadvantage as composition dealer has to pay tax at fixed % on his total sales including exempt goods.

If a dealer also supplies goods which are exempt and the proportion of exempt goods is more (examples- milk, curd, salt, bread, printed books, etc.) it may be better for him not to go for composition. If he goes for regular registration, he will pay tax as per rates applicable to each of the goods and hence he will not have to pay tax on exempt supplies. The best way to arrive at proper decision will be to compare the tax impact for the dealer under the two options (Regular Vs Composition). A small exercise may be very useful here as explained below:

Tax liability of the dealer under regular registration can be worked out based on the 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. 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.

The concept is explained below with two examples. The calculations in these examples are based on the following assumptions:

• The dealer is selling to individual consumers who are not interested in ITC on their purchases.
• His 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.

EXAMPLE- 1

Let us take practical example of a textile retailer (trader) selling different products such as suiting, shirting, sarees, readymade garments and other miscellaneous items. His turnover and margin for different items are estimated as under:

Regular registration: As per above calculation, he will be paying tax of Rs. 1,47,980 if he goes for registration as a regular dealer. Further his gross profit will be Rs. 15,06,000.

Composition: If the same dealer goes for composition option, he will be paying tax of only Rs. 83,540 (1% on his turnover of Rs. 83,53,980). In other words, he will be paying less tax by Rs. 64,440 and this reduction in tax will add to his profit as shown below:

Thus apparently he will be benefited by choosing composition option as it reduces his tax cost and increases his profit.

EXAMPLE- 2

For another person in a different type of business, regular registration may work out more beneficial over composition. For example, a dealer is having a provision store where he sells various types of food items. Most of his goods (such as unbranded food grains & pulses, bread, milk and milk products like curd, paneer, fruits & vegetables) fall under nil GST rate. In addition he sells some items attracting GST rates of 5%, 12% and 18%. Based on break-up of his sales, the figures are working out as under:

Here the dealer will be paying tax of Rs. 35,200 under regular option and his gross profit will be Rs. 10,90,000. But under composition option, his tax outgo will be Rs. 75,732 (more than double of the outgo under regular option). This increase in tax will reduce his profit as shown below:

 In this case, regular registration is more beneficial than composition option.

From the above examples, we can draw the following broad conclusions:

• Tax liability of the dealer under regular registration depends upon two major factors- first is his gross margin and second is the GST rates applicable to his products.
• The higher the margin, higher will be the tax liability for a regular dealer. Similarly, in case of goods attracting higher GST rates, his tax liability will also be higher.
• As far as a composition dealer is concerned, his tax rate remains fixed irrespective of the rates prescribed under GST tariff.

From the above discussion, it is clear that small businessmen (with aggregate turnover below Rs. 1 crore) can effectively use composition option as a tax planning tool and decide the type of registration suitable for them after comparing their tax liability under the two options (composition or regular).

Disclaimer: The views expressed in this article are personal and should not be considered as professional advice. The author may be contacted at sgkarwa@rediffmail.com.