Shortcomings of GST and effect on small entities


This Week has been full of news related to GST. Though believed to be a tough task, it is anticipated to come into effect from 1st July. Also giving due respect to the deadline expected by Government, recently on May 18 & 19, for the very first time rates for different items were fixed. While there is a lot of buzz around the benefits and objectives that will be met after GST comes into effect, our this article is on some shortcomings in GST regime as of now in its current form. The motive of this article is not to just criticize on shortcomings, but also to suggest some areas of improvements.

Withdrawal of Protection from SMEs

One of the main objective of earlier government including the present one has been to protect and assist in flourishing of SMEs. However, with lowering of threshold limit under GST onwards of which GST has to be paid is going to affect SMEs adversly. Earlier for a Small Manufacturing Entity, Excise Duty was collected only for turnover exceeding 1.5 crores. But, under Goods and Service Tax (GST), the same limit has been lowered to 20 lakhs. Also for certain classes of entities such as the one operating with interstate sales, this limit has been effectively lowered to Nil. Such exemptions were allowed to promote SMEs which otherwise would rarely be able to withstand competition from larger entities that have cost benefits from larger production.

Small Trader Lost Syndrome

Under GST, the credit for any inputs can only be claimed when the same has been paid by the selling party. If seller doesn’t pays GST, credit for the same cannot be claimed by buying trader. While this seems to be a logical check on tax evasion, it also creates a loss of small traders. Since, the risk of small suppliers in defaulting tax payment is viewed as high, the buyers will tend to buy from larger entities with high asset/turnover values. While there may not be fault of the small trader, still its sure to cost in terms of reduced sales.

Increase in Cost to maintain Good Ratings

Under new GST Regime, Government has planned to rate Entities based on their level of compliance under GST. While this is a good idea to promote compliances by entities, it is certain that cost of maintaining good ratings is going to be significant for the SMEs. While larger Entities are well placed to adopt ERPs, SMEs will struggle to comply as they will have to hire trained professionals for compliance under GST. Since, all invoices are to be updated to the GSTN server and for claiming credit, the balances should tally between the parties (else notices will be issued for mismatches), the cost of compliance is going to be increased significantly.

Denial of Composition Scheme

While there isn’t an expressed denial in the statutes, certain classes of entities are effectively denied to opt under composition scheme. For SMEs dealing through E-commerce mode, it is strictly barred to opt for Composition Scheme as they would be selling their products either directly or through other platforms to several states. This way, it would increase the compliances for start-up entities which are likely to struggle for increased compliances under GST. Allowance of Composition scheme being restricted to manufacturers and denying the same to service providers and online sellers will also place the SMEs at par with large entities in terms of compliances.

Lack of preparation for inflationary effects

In every country where GST has been introduced for the first time, it has been observed that initial period has been inflationary. This occurs due to entities increasing the prices due to increase in tax and compliances. While inflation is expected in India, it lacks the anti-profiteering laws to control such conditions. Also, there is increase in effective tax rate for most of the services which will see increase of 2-3% (reduced slightly due to allowance of certain credits that weren’t allowed earlier). This will push the prices up and since the event of applying GST is going to be disruptive in nature, it will also motivate businesses to skip passing of price reduction on account of tax efficiencies for compensating future cost of compliances.

These are just few of the effects of rolling out GST on SMEs. There are other indirect effects too. However, to implement GST not only for the prospect of tax revenue but also reducing compliances, Government needs to have some sort of remedies. It needs to provide some relaxation for SMEs and increase the basic exemption limits for manufacturing entities. In haste of increase tax coverage and increase taxes, it also needs to consider ratings in departmental efficiencies itself. Under GST it provides for ratings of Entities but, it is widely accepted fact that the small entities have fewer resources to negotiate with departments on several issues which many times prolong for longer period. Instead of just widening the tax ambit, Government also needs to introduce some mechanism that doesn’t punish small entities on account of faults and delays by the department’s mechanism itself.

While as a whole GST is beneficial in long run, it is sure to cause disruption in business cycles for short period. Also rates are based on HSN which requires even service providers to work more on invoicing and compliances. In absence of beneficial rates, default rates are certainly going to increase tax burden which with passage of time may be reduced by government on account of notification of such rates as considered suitable by government in future. But for now the question remains as to whether July 1 deadline will be met or not which falls in between of a financial year and tax payers are going to be forced to change their systems in between the financial year with effectively being subject to running compliances under parallel systems. Maybe the answer to mystery ahead lies with the date chosen which happens to most auspicious day in calendar during the history of Indirect taxation in India. But for now it is advisable for SMEs to gear up  for disruptive business cycle and be prepared for new Tax Regime.


  1. However, the online system of registration, payments, refunds and returns has proven to be a major point of pain for most SMEs (Small and Medium Enterprise), as they lack the technical expertise to deal with electronic systems, and therefore need to hiring intermediaries, which only adds to their compliance costs. Moreover, for small traders whose computer literacy is nil and who have no access to the internet, the GST has descended upon them as a digital shock.

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