Every quarter we onboard a handful of small consultancies, IT freelancers, and interior-design studios who chose the composition scheme in Year One because someone — a friend, a CA who doesn’t handle GST, a YouTube tutorial — told them the rate was “6% instead of 18%”. Two years later they are asking us how to come out, often with a tax demand notice from the department and a pile of unclaimed input tax credit (ITC) they cannot recover.

This is the working paper we walk them through.

The basic mechanics, restated

The composition scheme under Section 10 of the CGST Act lets a registered person with aggregate turnover up to ₹1.5 crore (₹75 lakh in special-category states) pay tax as a percentage of turnover, in lieu of the regular GST. For services other than restaurant service, the rate is 6% of turnover (3% CGST + 3% SGST, or 6% IGST for inter-state). Manufacturers and traders pay 1% and 1% respectively.

The cash-tempting part is the word “turnover”. It is not the value of supply. For a service provider, turnover means the full invoice value including any reimbursable expenses — without any deduction for input costs, sub-contractor fees, or purchases.

What you give up

When you opt in, three things happen on Day One that you cannot reverse easily:

You cannot collect GST on your invoices. You bill “inclusive of taxes”. Your customer knows they cannot claim ITC from your invoice, so a B2B customer who could otherwise have claimed 18% on your fee will negotiate harder.
You cannot claim ITC on your own purchases. Office rent, stationery, software subscriptions, telephone bills, professional fees paid to your CA or lawyer, even the GST paid on imported services — all of it is now a dead cost.
You cannot sell through e-commerce operators. Section 10(2)(d) read with Rule 6(2B) of the CGST Rules blocks supplies via an e-commerce platform that is required to collect tax at source (TCS). If your growth plan is Amazon, Flipkart, Zomato, Swiggy, or any marketplace with TCS, you cannot be on composition.

The reverse-charge landmine

The biggest trap in Year Two is reverse charge. As a composition taxpayer, you must pay GST on rent paid to a registered landlord under Section 9(3) and on services imported from outside India under Section 9(4). But you cannot claim that tax as ITC — because composition taxpayers cannot claim ITC, ever. The full 18% on rent becomes a dead cost.

For a small consultancy paying ₹1,00,000 a month in office rent in a Tier-1 city, the annual reverse-charge hit is ₹18,000 × 12 = ₹2,16,000 in tax with no credit. If you had been on the regular scheme, this would have been ITC. As a composition taxpayer, it is pure tax cost.

The breakeven, computed

Let us put a consultancy with ₹40 lakh annual fee revenue, ₹8 lakh in sub-contractor fees, ₹6 lakh in cloud/SaaS/tools, ₹3 lakh in office expenses, and ₹12 lakh in rent under the microscope.

Regular scheme (18% output, ITC on inputs):

Output GST: ₹40,00,000 × 18% = ₹7,20,000
Input GST: (₹8L + ₹6L + ₹3L + ₹12L) × 18% = ₹5,22,000 (assuming all inputs carry GST)
RCM on rent (still payable, but credit available): ₹12L × 18% = ₹2,16,000
Net GST payable: ₹7,20,000 − ₹5,22,000 = ₹1,98,000 (plus ₹2,16,000 RCM which is fully ITC)

In cash terms, the regular scheme costs ₹1,98,000 of GST paid to the government.

Composition scheme (6% on turnover, no ITC):

Composition tax: ₹40,00,000 × 6% = ₹2,40,000
Plus RCM on rent (no credit available): ₹2,16,000
Net cash out: ₹4,56,000

The composition scheme costs ₹2,58,000 more in this scenario. The consultancy is worse off by about 6.5% of revenue, and the supposedly “lower rate” turns out to be a higher effective burden.

When composition does make sense

Composition is genuinely useful for a narrow profile:

Pure B2C businesses with negligible input cost. A saree shop buying finished goods on which GST is paid and reselling with minimal value-add. The input credit would be small anyway.
Cash-constrained businesses that value cash flow over total tax. The lower rate means less cash out each quarter, even if the annual burden is higher. Sometimes survival beats arithmetic.
Businesses at the edge of the threshold. A business at ₹1.4 crore with input costs of 80% of revenue, no rent, no sub-contractors, may genuinely save under composition. We have seen two such clients in three years.

For everyone else, especially services, the regular scheme wins.

How to come out

If you are already on composition and the math looks bad, you can opt out on your own by filing FORM GST CMP-04 before the start of the next financial year. Once out, you cannot opt back in for one year.

If you crossed the ₹1.5 crore threshold (or ₹75 lakh in special-category states) — auto-exit. You file FORM GST REG-01 as a regular taxpayer within 30 days of crossing the threshold, and you must reverse any ITC you were claiming even though you shouldn’t have. This is where Year-Two surprises land. We have seen tax demands of ₹3-4 lakh on studios that grew across the threshold without noticing.

A short checklist before you opt in

Add up your full input GST — rent, software, professional fees, sub-contractors, imports — and confirm that the rate differential (12 percentage points for an 18%-rated service) doesn’t already cost you more than you save.
Confirm that you have no B2B customers who will insist on ITC-eligible invoices. If your top three customers are all registered and they each have ₹50 lakh+ ITC on the table, they will push you to the regular scheme.
Confirm that you will not need an e-commerce channel in the next 12 months.
Set a calendar reminder for the threshold. If you are at ₹1.2 crore in November, plan the migration now.

If any of these four checks fail, stay on the regular scheme. The “6% vs 18%” headline is real but misleading — the real comparison is “what’s my effective tax cost after ITC”, and the answer almost never favours composition for services.

If you want us to run this comparison for your actual numbers, share your last year’s revenue and cost mix on WhatsApp — we will tell you which side of the breakeven you are on.