Composition scheme

Indian Economy glossary

Also called: Composition levy · Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Beyond NCERT

Meaning

The composition scheme (also called composition levy) is an optional, simpler way to pay GST for small taxpayers whose turnover (total sales) is below a set limit. They pay a small flat rate on their turnover and file fewer, simpler returns. In return, they get no input tax credit (ITC) (credit for GST already paid on their purchases) and cannot make inter-state supplies (sales across a state border).

It matters because it lowers the cost of following the rules for India's many small shops, eateries and service providers. The catch is that it breaks the GST credit chain, and that affects how much tax builds up and who wants to trade with these small firms.

Formula: Composition tax payable = Turnover × Flat composition rate (there is no deduction for ITC)
Compare the normal GST formula: GST payable = Output tax − Input tax credit

Explanation

How it works

Who can opt in: a small taxpayer whose turnover is below the limit for its category.

Category	Turnover limit	Rate on turnover
Traders and manufacturers	₹1.5 crore (₹75 lakh in special-category states)	1%
Restaurants	₹1.5 crore	5%
Service providers	₹50 lakh	6%

What the dealer gets:
It pays tax at a low flat rate on total sales. It does not work out tax sale by sale at the normal rates.
It files fewer, simpler returns. This saves time and accountant fees.
What the dealer gives up:
No ITC. The GST it paid on its purchases cannot be set off. That tax becomes part of its cost.
No inter-state supplies. It can only sell inside its own state.
No credit passed to buyers. A registered business that buys from a composition dealer cannot claim ITC on that purchase.

Why "no ITC" matters: the credit chain breaks

Under normal GST, each business pays tax only on the value it adds. This is because ITC cancels out the tax paid at earlier stages.
A composition dealer sits outside this chain.
Tax on its inputs gets stuck. It cannot be claimed back, so it is built into the dealer's price.
The next buyer gets no credit. It then pays full output tax on a price that already contains hidden tax.
Result: some cascading (tax on tax) comes back at that point in the chain.

Worked example (illustration only)

Take a trader in a normal state with yearly sales of ₹1 crore, which is below the ₹1.5 crore limit.

Under the composition scheme (1%):
Tax = ₹1 crore × 1% = ₹1 lakh.
It cannot claim any GST it paid on purchases.
Under normal GST at the 18% standard rate:
Say it buys goods worth ₹80 lakh and pays ₹14.4 lakh GST on them. This is its ITC.
Output tax = 18% of ₹1 crore = ₹18 lakh.
GST payable = ₹18 lakh − ₹14.4 lakh = ₹3.6 lakh.
What this shows:
The composition tax is lower and the paperwork is lighter.
But the ₹14.4 lakh input tax is now a cost for the trader and cannot be recovered.
Its registered buyers get no credit, so they may prefer a normal taxpayer as their supplier.

When the scheme suits a business, and when it does not

Suits: firms that sell mostly to final consumers, who cannot claim ITC anyway. Examples are small kirana shops and local eateries. It also suits firms whose purchases carry little GST.
Does not suit:
Firms that sell mainly to registered businesses (B2B), because their buyers want ITC.
Firms that want to sell across state borders.
Firms whose purchases carry heavy GST, because they would lose all of that credit.

In India

Legal base: the scheme is part of the CGST Act (central GST law), which came into force when GST began on 1 July 2017. The SGST Acts passed by each state match it.
Who sets the limits and rates: the GST Council under Art. 279A of the Constitution recommends them. This article was added by the 101st Amendment Act, 2016, which got presidential assent on 8 September 2016.
Special-category states: the limit for traders and manufacturers is lower in these states, at ₹75 lakh instead of ₹1.5 crore.
Where it is done: opting in, filing returns and paying tax all happen on the GSTN portal (www.gst.gov.in).
Scale: India has over 1.51 crore active GST registrations as of 30 April 2025 [1]. Many of these are small businesses, and the composition scheme is meant for them.
Link to formalisation: the scheme makes it cheap and easy for small firms to register. This fits the wider pattern of rising collections and a growing registration base. Gross GST reached ₹22.08 lakh crore in 2024-25 [1].

Don't confuse with

Registration threshold: below this turnover a business does not need to register for GST at all. A composition dealer is registered and pays tax, just at a low flat rate.
Normal (regular) taxpayer: pays tax at the slab rates, claims ITC, can sell inter-state and passes credit to buyers. A composition dealer can do none of these.
Exempt / nil-rated supply: no GST is charged on the item itself. Under the composition scheme, the dealer pays a flat tax on its whole turnover. In both cases, no ITC is available.
Reverse charge mechanism (RCM): the buyer pays the GST to the government. Under the composition scheme, the seller (the small dealer) pays the flat tax itself.

Prelims Hooks

Composition scheme = flat tax on turnover, no ITC, no inter-state supplies, fewer returns. It is optional.
Rates: 1% for traders and manufacturers, 5% for restaurants, 6% for service providers.
Turnover limits: ₹1.5 crore for traders, manufacturers and restaurants (₹75 lakh in special-category states); ₹50 lakh for service providers.
Trap: a registered buyer cannot claim ITC on purchases from a composition dealer.
Trap: a composition dealer cannot sell to another state, so it never charges IGST on its sales.
Limits and rates are set on the recommendation of the GST Council (Art. 279A). They are not fixed in the Constitution.

Mains Points

Simplicity vs neutrality:
The scheme cuts compliance cost for MSMEs and brings them into the formal tax net.
But it breaks the ITC chain. Hidden tax then builds up at the composition dealer's stage, which goes against GST's aim of taxing only value addition.
Market access trade-off for small firms:
No inter-state sales and no credit for buyers push composition dealers out of B2B supply chains. Registered firms prefer suppliers who pass on credit.
So a small firm must choose between low paperwork and access to bigger markets. This is a key issue for MSME growth and the "common national market" that GST promised.
Formalisation and revenue:
Easy entry helps widen the base, as seen in 1.51 crore registrations (April 2025) and record ₹22.08 lakh crore collections in 2024-25 [1].
Very low flat rates also carry a risk: firms may keep their reported turnover under the limit, or split into smaller units, to stay in the scheme. The limits need to be reviewed from time to time.

Related concepts

GST architecture: dual, destination-based, credit-linked

Sources

1Record Gross GST collection in 2024–25 / Eight Years of GSTpib.gov.in · tier 1