Composition Levy – Does it Really Make Sense?

The biggest Tax reform in Independent India, Goods and Services Tax Act (GST) has brought on a platter, a concept called “Composition Levy’ to its taxpayer.

Obviously, this is not a new concept to the Value Added Tax regime. Way back in 2003, this concept was introduced in State VAT ACT under which the dealer is required to pay a fixed rate of tax on his declared turnover, and no VAT set off / credits would be down the supply chain. The biggest attraction for a dealer then, under that law, was that they were not required to maintain proper books of Accounts, or records of material transacted under VAT law. It goes without saying that if they were maintaining books it was not subject to scrutiny under the respective VAT laws.

Composition Levy in the GST Regime

A similar concept will be introduced in model GST law. Let us understand the essence of this.

  • Sec 8 of model law deals with this concept
  • It is an optional scheme –Taxpayer has the option to choose or not
  • Proposes to pay an amount calculated at prescribed rate on the turnover of the taxable person in lieu of regular tax under GST.
  • Rate would be notified by the GST Council. As per reports, the council is mulling a rate in the range of 7% to 9%.
  • Permission of proper officer of the central or state government is required for adopting this Scheme.
  • Only a registered taxable person can opt for the scheme
  • Aggregate turnover of such person shall not to exceed 50 lakhs in a financial year
  • Aggregate turnover to be computed for all taxable persons, on all India basis, having the same PAN.
  • Aggregate turnover includes values of Taxable, Non-taxable, exempt and export turnover. However, reverse charge and inward supply are not included.
  • Under this scheme, a person neither collects tax from recipient nor is eligible for an Input tax credit
  • This scheme is not available if a person is paying tax under reverse charge mechanism and or deals in interstate supplies of goods and services.
  • Permission under the scheme may be cancelled if the proper officer has reason to believe (with or without documentary evidence!!!) that:
      • Taxable person was not eligible under the scheme
      • Permission granted earlier was incorrectly granted.

    (Of course the provisions of show cause notice and opportunity for personal hearing shall be applicable).

  • The consequence of such cancellation is that a taxable person shall end up paying differential tax (regular tax less composition rate) and equivalent penalty.

Some Unanswered Questions

There are a few unanswered questions in the model law relating to this scheme. Let us go over them:

  • What happens when turnover exceeds the prescribed limits during the financial year?
  • Will the Composition rate be CGST+SGST or CGST or SGST?
  • Will this scheme be restricted to any particular categories of taxable persons or open to all?
  • If one unit of a taxable person fails to comply with the provision of the law, does the status as a composite tax payer for all the other units get cancelled?
  • What happens if a composition person collects tax? Will it be forfeited?

We hope all of the above questions will see the light of the day in the final GST law and Rules.

Now that we have dissected Sec 8 of the Model GST law, let us explore the much hyped Composition Levy.

The following use case can help us understand it better:

Krishna Agency is an authorised distributor of Hindustan Unilever’s product “Surf Excel” for Mysore city. Krishna Agency purchases “Surf Excel” from HUL’s State distributor AZC Pvt Ltd from Bangalore. Krishna Agency sells Surf Excel to retail outlets like Kaushik stores.

There are 4 different GST Combinations that are possible for Krishna Agency and for Kaushik stores.

Assumptions

  1. MRP of Surf Excel Matic 2 Kg pack is Rs. 379  (MRP shall be still relevant under Legal Metrology Act 2009 though would become irrelevant under GST)
  2. GST Rate is presumed at 20% (CGST+SGST)
  3. Composition Levy presumed at 8% on turnover
  4. FMCG distributor’s maximum selling price is fixed and a retail sale must take place at MRP or less as per law.
  5. Composition dealer neither collects tax from recipient nor is eligible for an Input tax credit

Scenario 1

 MRP of SURF EXCEL MATIC (2 KG pack) – Rs 379

 Description AZC Pvt Ltd Krishna Agency Kaushik Stores
Transaction type B2B B2B B2C
GST option Regular Regular Regular
Cost Price (A) 200 220 253
 Sale  Price (B) 220 253 316
GST@ 20% 44 51 63
Total Cost 264 304 379
Less Input tax Credit 40 44 51
Net Total Cost 224 260 328
Margin  less incremental GST  
Margin (B)-(A) 20 33 63
Less Composition Tax NA
Net Margin 20 33 63

GST is not cost since Krishna Agency and Kaushik stores are recovering GST paid on purchases.

Scenario 2

MRP of SURF EXCEL MATIC (2KG pack) – Rs 379

 Description AZC Pvt Ltd Krishna Agency Kaushik Stores
Transaction type B2B B2B B2C
GST option Regular Composition Regular
Cost Price (A) 200 264 304
Sale Price (B) 220 304 316
GST@ 20% 44 0 63
Total Cost 264 304 379
Less Input tax Credit 40 0 0
Net Total Cost 224 304 379
Margin  less incremental GST  
Margin (B)-(A) 20 40 12
Less Composition Tax NA 24 0
Net Margin 20  16 12

GST is cost since Krishna Agency is under Composition Levy.

Scenario 3

MRP of SURF EXCEL MATIC (2KG pack) – Rs 379

 Description AZC Pvt Ltd Krishna Agency Kaushik Stores
Transaction type B2B B2B B2C
GST option Regular Composition Composition
 Cost Price (A) 264 304
Sale Price (B) 220 304 379
GST@ 20% 44 0 0
Total Cost 264 304 379
Less Input tax Credit 40 0 0
Net Total Cost 224 304 379
Margin  less incremental GST  
Margin (B)-(A) 20 40 75
Less Composition Tax NA 24 30
Net Margin  20 16 45

GST is cost since Krishna Agency & Kaushik Stores are under Composition Levy.

Scenario 4

MRP of SURF EXCEL MATIC (2KG pack) – Rs 379

Description AZC Pvt Ltd Krishna Agency Kaushik Stores
Transaction type B2B B2B B2C
GST option Regular Regular Composition
 Base Price (A) 220 304
Sale Price (B) 220 253 379
GST@ 20% 44 51 0
Total Cost 264 304 379
Less Input tax Credit 40 44 0
Net Total Cost 224 260 379
Margin  less incremental GST  
Margin (B)-(A) 20 33 75
Less Composition Tax NA 0 30
Net Margin  20 33 45

GST is not cost for Krishna Agency since under Regular Levy & Cost to Kaushik Stores since under Composition Levy.

What Else do we need to Consider?

Further, from compliance front, a Composition dealer is required to file a quarterly return as per GSTR-4. In this return, he needs to provide Invoice wise details of his purchases including overseas purchases of Goods and Capital Goods and all outward supplies summary. Even under GST, a Taxable person registered under Composition is not required to maintain books of Accounts, and records of transaction of materials as per the law. However, when so many details are required, is the intent in the law the same or is it simply an eye wash?
If you dig deeper, when the composition dealer sells, he either sells to another composite dealer (whose GSTR-4 becomes supplies of the seller) or another dealer (whose GSTR-2 becomes his supplies of the seller). In other words, the books can be reconstructed with details of inward and outward supplies on GSTN systems. Does this really give the dealer a break and can you escape the eyes of the taxman whichever way?

So if you put two and two together, you are required to maintain books of accounts and above all, are subject to scrutiny.

In addition to this, there are complications and restrictions in the form of:

  • If you opt for composition in one state, you need to opt in other states too.
  • Restriction to do inter-state sales (IGST)
  • Restriction on reverse charge purchases etc.

With all these complications, a Composition Levy under GST is neither practical nor beneficial.

However, all of the above needs to be taken with a pinch of salt. If the trader is purely into B2C business, the composition rate is low and the net margins are higher, composition may turn out to be a viable option.

A trader needs to take an informed call if it really makes sense for him to opt under this scheme.

Co-authored by Sathya Pramod (Chief Financial Officer, Tally Solutions) and Shivadutt B (Company Secretary and Head – Legal, Tally Solutions).

About the author

Sathya Pramod & Shivadutt B

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