Composition Scheme under GST: Benefits, Conditions and Practical Risks

Many small businesses opt for the GST Composition Scheme believing it will permanently simplify their tax compliance. In practice, several businesses later discover that the scheme restricts their ability to grow, raise invoices properly, or deal with larger clients.

Side-by-side comparison of Regular GST and Composition Scheme in India covering turnover limit, input tax credit, invoice type, inter-state supply and tax rates.

The Composition Scheme is designed to reduce compliance burden for small taxpayers by offering lower tax rates and simplified return filing. However, it comes with strict conditions and limitations that are often overlooked at the time of opting in.

This article explains the Composition Scheme under GST in a practical and structured manner. It focuses on eligibility, tax rates, benefits, and—most importantly—the risks that startups and small businesses must evaluate before choosing this scheme.

📘 What Is the GST Composition Scheme?

The Composition Scheme is an optional compliance scheme under GST that allows eligible small taxpayers to pay tax at a fixed rate on turnover, instead of charging GST at regular rates on invoices.

Businesses under the scheme:

Pay tax out of their own pocket
Cannot collect GST from customers
Cannot claim input tax credit (ITC)

The primary objective is to simplify compliance, not to reduce tax liability in all cases.

🧠 Who Is Eligible for the Composition Scheme?

A registered person can opt for the Composition Scheme if:

Aggregate turnover in the preceding financial year does not exceed the prescribed limit
The person is not engaged in ineligible supplies
The person complies with all conditions of the scheme

Turnover Limit

₹1.5 crore for most states
₹75 lakh for special category states

Turnover is calculated on an aggregate turnover basis, not state-wise.

🏢 Tax Rates under the Composition Scheme

Category of Taxpayer	Composition Tax Rate
Manufacturers	1% of turnover
Traders	1% of turnover
Restaurants (non-AC, no alcohol)	5% of turnover
Service providers (special scheme)	6% of turnover

These rates are applied on turnover, not profit.

📊 Regular GST vs Composition Scheme – Comparison Table

The following table provides a practical comparison between the regular GST scheme and the composition scheme to help businesses choose correctly.

Particulars	Regular GST Scheme	Composition Scheme
Eligibility	Any registered taxable person	Only eligible small taxpayers meeting conditions
Turnover Limit	No upper limit	₹1.5 crore (₹75 lakh for special category states)
Nature	Normal tax mechanism	Optional simplified scheme
Tax Rate	As per GST rate slabs (5%, 12%, 18%, 28%)	Fixed rate on turnover (1%, 5%, or 6%)
GST Collection from Customer	✅ Allowed	❌ Not allowed
Input Tax Credit (ITC)	✅ Available (subject to conditions)	❌ Not available
Type of Invoice	Tax Invoice	Bill of Supply
Inter-State Supply	✅ Allowed	❌ Not allowed
Supply through E-Commerce	✅ Allowed	❌ Not allowed
Exports / Zero-Rated Supply	✅ Allowed	❌ Not allowed
Reverse Charge Liability	Applicable where notified	Applicable where notified
Return Filing Frequency	Monthly / Quarterly + Annual	Quarterly + Annual
Compliance Complexity	Higher	Lower
Suitable For	Growing businesses, B2B suppliers, exporters	Small local B2C businesses
Impact on Pricing	Neutral if ITC is passed on	ITC cost absorbed by business
Scalability	High	Limited

🔹 Quick Practical Interpretation (Highly Useful for Readers)

Regular Scheme is better when:
- Customers need GST invoices
- ITC forms a significant part of cost
- Business plans inter-state expansion
- Growth is expected
Composition Scheme is better when:
- Business is local and B2C-focused
- ITC impact is minimal
- Turnover is stable and predictable
- Compliance simplicity is priority

🔹 One-Line Business Decision Rule (Very Effective)

If your customer asks for ITC or GST invoice, composition scheme is usually not suitable.

🏢 Practical Business Impact

For Small Businesses

The scheme reduces:

Number of returns
Detailed compliance requirements

However, businesses must absorb GST cost themselves, which may impact margins.

For Startups

Startups planning rapid growth may find the scheme restrictive due to:

Inability to make inter-state supplies
Ineligibility to claim ITC
Reduced acceptance by corporate clients

For Students & Learners

The Composition Scheme highlights how GST balances ease of compliance with revenue protection, making it an important conceptual topic.

📊 Practical Example

Example:

ABC Traders, a small retail business with ₹90 lakh turnover, opted for the Composition Scheme to simplify compliance. Over time:

Corporate customers refused to deal due to lack of GST invoice
Input tax credit on purchases became a cost
Inter-state expansion plans were blocked

Eventually, the business had to shift to the regular scheme mid-year, resulting in additional compliance adjustments.

This demonstrates that simpler compliance does not always mean better business fit.

⚠️ Key Restrictions under the Composition Scheme

A composition taxpayer:

Cannot collect GST from customers
Cannot claim input tax credit
Cannot make inter-state outward supplies
Cannot supply through e-commerce operators
Must issue a “Bill of Supply” instead of tax invoice

Violation of these conditions leads to denial of scheme benefits and penalty exposure.

⚠️ Common Mistakes & Misinterpretations

Opting for composition only to reduce paperwork
Ignoring ITC cost while pricing goods
Assuming scheme suits all small businesses
Not tracking turnover crossing limits
Making ineligible supplies unknowingly

Most disputes arise because businesses do not reassess suitability periodically.

✅ Composition Scheme Decision Checklist

Review business model and growth plans
Check nature of customers (B2B vs B2C)
Evaluate ITC impact on pricing
Monitor aggregate turnover regularly
Assess inter-state supply requirements

❓ Frequently Asked Questions (FAQs)

Q1. Is the Composition Scheme cheaper than regular GST?

Not always. Loss of ITC can make it costlier despite lower tax rates.

Q2. Can a service provider opt for the Composition Scheme?

Yes, under a special scheme, subject to conditions and turnover limits.

Q3. Can I switch from composition to regular scheme later?

Yes, but proper compliance adjustments are required at the time of transition.

🧠 Conclusion

The GST Composition Scheme is a compliance simplification tool, not a universal solution for small businesses. While it reduces procedural burden, it introduces operational and commercial limitations that may affect long-term growth.

For startups and small enterprises, the decision to opt for composition should be based on business model, customer profile, and expansion plans, not just turnover size. Periodic reassessment is essential to ensure continued suitability.

🔍 Professional Note

The Composition Scheme works best for stable, local, B2C-focused businesses with limited input tax credit exposure.

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