Levy and Exemptions Under GST (2026 Updated Guide)

 

GST Levy refers to when tax becomes payable on a supply of goods or services under the CGST and IGST Acts, 2017. GST Exemption refers to specific goods or services on which GST is not charged as notified by the government.

Understanding both is critical for small businesses navigating the Rs. 40 lakh threshold and MSME compliance in 2026.

What Is Levy Under GST?

Look, the word “levy” sounds bureaucratic, but it’s simpler than you think.

Under Section 9 of the CGST Act, GST becomes payable the moment you make a supply of goods or services. Not when you manufacture something. Not when you sell it in the traditional sense.

The taxable event is the supply itself—whether it’s a product, a service, or even a deemed supply like stock transfers between branches.

Here’s the thing most people miss: levy doesn’t automatically mean you pay tax. It means tax becomes applicable on that transaction. Whether you actually pay depends on exemptions, thresholds, and your registration status.

That’s where the confusion starts, especially for startups hovering around the Rs. 40 lakh aggregate annual turnover (AATO) mark.

The CGST Act clearly defines this under Section 9(1): “Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both.”

The IGST Act mirrors this for inter-state transactions. What matters is understanding when the levy kicks in and when it doesn’t.

For businesses just starting out, this is where GST registration requirements become relevant. If you’re below the threshold, you’re exempt from registration—but you’re still technically under the levy framework for any future supplies once you cross that line.

When Does GST Levy Apply?

GST levy applies when four conditions align:

1. You’re registered (or required to be registered)
2. You make a taxable supply (goods/services that aren’t exempt)
3. The supply happens within India (place-of-supply rules matter here)
4. It’s not a reverse charge scenario where the recipient pays

The Rs. 40 lakh threshold for goods and Rs. 20 lakh for services is your safety net. In Special Category States (SCS)—think hilly regions, North-East—it drops to Rs. 20 lakh and Rs. 10 lakh respectively.

If your AATO stays below these, you’re not required to register, so the levy doesn’t materialize into an actual tax obligation.

But here’s the ugly truth: reverse charge on exempt supplies trips up a lot of small businesses.

Say you’re sourcing exempt goods from an unregistered supplier. Under Sections 9(3) and 9(4), you might end up paying GST under RCM even if your own supplies are exempt. I’ve seen retailers accidentally trigger registration because they didn’t structure these as nil-rated supplies via a CA’s advance ruling.

Community fix? Get that ruling upfront—it’s tedious but saves you from unwanted compliance.

Inter-state supplies also complicate things. If you’re in Maharashtra selling to a buyer in Gujarat, IGST applies. The levy shifts from state jurisdiction to central, which matters for how GST tax is levied and paid through GSTR-3B.

What Are GST Exemptions?

Exemptions are where the levy stops short of becoming a tax liability. The government issues notifications under Section 11 of the CGST Act specifying goods and services that are exempt.

But—and this is critical—there are four types of “no GST” scenarios, and they’re not interchangeable:

• Exempt Supplies: No GST charged, but you can’t claim Input Tax Credit (ITC) on inputs. Example: fresh milk.
• Nil-Rated Supplies: GST rate is 0%, but treated differently than exempt. Example: certain grains.
• Zero-Rated Supplies: Exports. You charge 0% but can claim ITC refunds.
• Non-GST Supplies: Outside the GST framework entirely. Example: alcoholic liquor for human consumption.

Most small businesses conflate exempt and nil-rated. The distinction matters for ITC claims. If you’re supplying exempt goods, the ITC on your inputs gets blocked.

If it’s nil-rated, you’re in a better position for refunds under the inverted duty structure provisions introduced post-56th GST Council (September 2025).

Honestly, the 2026 reforms around provisional ITC refunds are a game-changer for MSMEs stuck in cash flow crunches. Previously, 80% of small businesses reported 3-6 month delays getting refunds.

Now, if you’re in an inverted duty scenario—where input tax exceeds output tax—you can access provisional refunds faster. Pair this with TReDS (Trade Receivables Discounting System) for invoice discounting, and you’re not bleeding cash waiting for the government to process GSTR-3B.

Common GST Exemptions for Small Businesses (2026)

Here’s the practical list. I’m pulling from Notification 2/2017-Central Tax (Rate) and Notification 12/2017-Central Tax (Rate), updated through 2026 amendments:

Full list available at CBIC GST Rates Portal.

The catch? Conditional exemptions. Take education services—they’re exempt only if provided by eligible institutions. If you’re running a private coaching center structured as a for-profit entity, you might not qualify.

Same with healthcare: diagnostic services are exempt, but cosmetic procedures aren’t.

One more thing: post-sale discount valuation rules (eased in 2026) now let you issue GST credit notes without disputes. Previously, adjusting invoices for discounts post-supply was a compliance nightmare. The 56th GST Council streamlined this, so your credit note flow through GSTR-1 is cleaner.

The Composition Scheme: Your Rs. 1.5 Crore Lifeline

If your turnover is between Rs. 40 lakh and Rs. 1.5 crore, the Composition Levy is your best friend.

You pay a flat 1% (goods), 5% (restaurants), or 6% (other services) instead of normal GST rates. No complex invoicing. Quarterly filings instead of monthly.

But here’s the friction: you can’t scale beyond Rs. 1.5 crore without exiting the scheme entirely.

I’ve seen businesses hit that ceiling and panic because switching to regular GST means retroactive compliance resets. The community fix?

Hybrid model. Structure your exports separately under regular GST (zero-rated) while keeping domestic supplies under Composition for as long as possible. It’s not officially documented, but CAs use quarterly Composition + selective regular registration to manage the transition.

Also, e-invoicing exemptions apply if your AATO is below Rs. 5 crore. MSMEs under Rs. 40 lakh turnover skip e-invoicing entirely, cutting compliance costs by 30%. That’s huge when you’re bootstrapping.

Is My Small Business GST-Exempt in 2026?

Short answer: If your AATO is below Rs. 40 lakh (goods) or Rs. 20 lakh (services), yes—you’re exempt from registration. SCS thresholds are Rs. 20 lakh and Rs. 10 lakh.

Agriculturists and suppliers of nil-rated goods (like fresh milk) qualify without filing.

Check your eligibility via the GST portal, and if you’re eligible for Composition, you can operate up to Rs. 1.5 crore with minimal filings.

This is the snippet-friendly answer for voice search and AI Overviews. But in practice, exemption doesn’t mean you ignore GST. If you’re sourcing from registered suppliers, you’re still dealing with GST on your input costs—you just can’t claim ITC.

How Do MSMEs Claim 2026 ITC Refunds Faster?

Direct answer: Post-56th GST Council, provisional refunds apply to inverted duty structures.

Use TReDS for invoice discounting to bridge cash flow gaps. File accurate GSTR-3B with post-sale discount valuations to avoid delays—this reduces cash lock-up by 3-6 months for 80% of MSMEs.

Practically, here’s what works: If you’re a manufacturer where input GST (say, 18%) exceeds output GST (5% on final product), you’re in an inverted duty scenario.

Previously, refunds took forever. Now, provisional refunds are processed faster if your documentation is clean. The trick is maintaining real-time reconciliation between GSTR-2A (auto-populated from supplier filings) and your purchase records.

GSTR-3B return filing accuracy is non-negotiable here.

Can Startups Avoid RCM on Exempt Goods?

Answer: Structure exempt purchases as nil-rated supplies and get a CA advance ruling.

If you have no taxable outward supplies, you’re exempt from registration. Common fix: Hybrid Composition for businesses scaling past Rs. 40 lakh—prevents unwanted compliance triggers.

RCM is the silent killer for startups. You buy from an unregistered vendor thinking you’re saving money, then realize you owe GST under reverse charge.

The Interim Appellate Authority for Advance Rulings (introduced in 2025) now fast-tracks these clarifications, cutting litigation risk.

Budget 2026 MSME Demands: What’s Changing?

Ahead of Budget 2026-27, MSME lobbies are pushing hard for GST cuts on essentials like milk, sugar, and edible oils.

Margins have eroded 15-20% post-pandemic, and small retailers are drowning in compliance costs.

The demand for merit rate simplification—consolidating the current 5%, 12%, 18%, 28% slabs into fewer tiers—is gaining traction.

Also on the table: expanding provisional refunds beyond inverted duties to general ITC claims. If passed, this would be massive for working capital management.

Right now, cash flow crises hit 56% of small retailers waiting for refunds. TReDS adoption is climbing, but it’s still not mainstream for businesses under Rs. 1 crore turnover.

Levy vs. Exemption: Real-World Scenarios

Let’s say you run a small organic grocery store in Pune.

You sell fresh milk (exempt), packaged spices (5% GST), and imported olive oil (18% GST). Here’s how levy and exemption interact:

• Fresh milk: Exempt supply. No GST charged, no ITC on inputs used for milk storage.
• Packaged spices: Taxable at 5%. You charge GST, claim ITC on packaging materials.
• Olive oil: Taxable at 18%. Full ITC available.

Your GSTR-1 filing will separate these. The milk sales don’t contribute to your taxable turnover for threshold calculations, but they do count toward AATO for registration purposes.

This is where businesses mess up—they think exempt supplies mean they’re invisible to GST. Nope. You still report them; you just don’t collect tax.

If you’re mixing exempt and taxable supplies, ITC apportionment rules under Section 17(2) apply. You can’t claim full ITC on common inputs (like electricity for the store). You’ll need to reverse a portion based on the exempt supply ratio.

This is tedious, which is why tools that automate ITC calculations—like what we built into ProfitBooks—save hours during monthly return filing.

Key Takeaways

• GST levy = when tax becomes payable on supply, not sale or manufacture
• Exemptions ≠ nil-rated ≠ zero-rated—each has different ITC implications
• Threshold safety: Rs. 40L (goods), Rs. 20L (services); SCS at Rs. 20L/10L
• Composition Scheme caps at Rs. 1.5 Cr with simplified 1% levy
• 2026 reforms: Provisional ITC refunds, TReDS for cash flow, post-sale discount ease
• RCM traps: Get advance rulings to avoid accidental registration
• Incorrect classification = penalties—especially for mixed supply scenarios

Frequently Asked Questions

What is the difference between levy and collection under GST?
Levy is when tax becomes legally payable under the CGST/IGST Acts. Collection is the actual mechanism of receiving that tax—either from the supplier (forward charge) or recipient (reverse charge). You can have a levy without collection if the supply is exempt.

Which goods are fully exempt from GST in 2026?
Fresh milk, unbranded atta, unprocessed agricultural produce, and certain educational/healthcare services remain exempt under Notification 2/2017 and 12/2017. Full list at CBIC’s official portal.

Do I need GST registration if I only sell exempt goods?
No, if your supplies are purely exempt or nil-rated and you have no taxable supplies, registration isn’t required. But if you cross the AATO threshold with mixed supplies, you must register.

How does the Composition Scheme affect exemptions?
Composition taxpayers pay a flat rate (1%-6%) on taxable supplies. Exempt supplies remain exempt, but you can’t claim ITC on any inputs—whether for taxable or exempt supplies.

What is inverted duty structure and how do refunds work?
It’s when input tax exceeds output tax (e.g., 18% on raw materials, 5% on finished goods). Post-56th GST Council, provisional refunds are available within 60 days if GSTR-3B is filed accurately.

Can I use TReDS if I’m not GST registered?
TReDS (Trade Receivables Discounting System) requires you to be a registered MSME with GSTIN for invoice discounting. It’s designed for businesses facing delayed payments from registered buyers.

What happens if I misclassify an exempt supply as taxable?
You’ll overcollect GST and need to refund customers or deposit excess tax. Misclassification also triggers notices during GST audits. Use HSN/SAC codes carefully and cross-check with CBIC notifications.

Are services to government bodies exempt?
Not automatically. Government contracts may involve reverse charge (RCM) or TDS under GST. Check Notification 13/2017 for specific exemptions like services by government entities to other government bodies.

How do I switch from Composition to Regular GST?
File Form GST CMP-04 before the start of the financial year (or within 7 days of crossing Rs. 1.5 Cr). You’ll need to start issuing GST invoices with full tax rates and monthly filings.

What is the penalty for not registering when required?
10% of tax due (minimum Rs. 10,000) under Section 122 of the CGST Act. Plus interest at 18% per annum on unpaid tax. Voluntary disclosure before detection reduces penalties.

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Reviewed on: May 2026

References:
CGST Act 2017 (CBIC)
GST Rates & Exemptions (CBIC)
GST Portal