Wednesday, 8 April 2020

Covid-19 crisis and The Way of Tao


Coronavirus spread has devastated the entire globe. The devastation has not just created a healthcare crisis but also economic and existential. But most horrific thing about this crisis is that it has, with its global spread at fast pace, turned much adorable “globalization” into a curse. This curse is not limited to the spread of virus across borders but with the closure of international boundaries it has stopped the flow of goods across the globe because globalization has resulted into vast distances in demand centers and supply centers like USA is facing extreme troubles in procurements because China is its main supplier although many supply centers in china are in fact owned by American companies. It is not that these products can’t be manufactured in USA or something near but these are being manufactured in china and then travelled to thousand kilometers just because of profit or lower costs. But all this has really rendered our world an extremely complex place.

But amid all this chaos, one day I happened to remember one great piece of wisdom about state of utopia…the ideal place to live life and it describes Utopian state is a small country of few people who love their homes so much that they do not like to travel, they are content with healthy food and useful clothes, they enjoy the labor of their hands. These words are from the great Chinese mystic Lao Tzu (Laozi) and are taken from verse 80 of his book “Tao Te Ching”. His words continued to come into my mind all the time recently. It is strange that I am missing this great man now in most difficult times but the wisdom of Lao Tzu was never more relevant than it is now. It is quite ironic that china is the epicenter of current covid crisis which is the birth place of Lao Tzu and Taoism. Let me reproduce this great Verse:

Imagine a small country with few people:
they have weapons and do not employ them;
they enjoy the labour of their hands and
do not waste time inventing labor-saving machines.
They take death seriously and do not travel far.
Since they dearly love their homes, they are not interested in travel.
Although they have boats and carriages, no one uses them.
They are content with healthy food, pleased with useful clothing,
satisfied in snug homes, and protective of their way of life.
Although they live within sight of their neighbours,
and crowing cocks and barking dogs can be heard across the way,
they leave each other in peace while they grow old and die.

Actually Utopia is not a physical state (and quite possible that it may never be created but going near is possible) but it is related to mental state first. So Utopia is not a place of vast flashy palaces, no work, vast variety of food…not at all. But Utopia is when we live our lives in simplicity (without striving too hard for everything and thus missing the present moment of bliss), harmony with nature (No over exploitation of natural resources) and contentment with what we have.

But let me clear some things about Lao Tzu. People often take him as supporter of laziness (doing nothing and sitting silently). But when I read him I did not find anything like this. In fact, Lao Tzu does not talk about fixed dogmas…fixed rules to live life. He feels everyone shall find his own path. In my view, this misunderstanding of Lao tzu is due to our misunderstanding of simplicity and contentment. We think simplicity happens when someone wears plain white clothes (not costly), eats vegetables and rice and no meat, and rides on a cycle. But this is not the meaning. Simplicity and contentment happens when we do not strive madly for achieving and getting something because in this madness we’ll miss the present moment which we can enjoy. So we are simple when we enjoy what we have or can have without resorting to “over-doing” because this “over-doing” is going to break the balance of our lives and natural resources.

Many authors have accused Lao Tzu for supporting backwardness and boring life. But I think there is tremendous amount of misunderstanding of this great man mainly because Lao Tzu was way ahead of us in the understanding of subtle forces of life and then cryptic language of his book has made people to interpret it as per their level of consciousness and wisdom. But Lao Tzu was not backward or anti-growth. In this verse, he is not asking to not to produce weapons and boats. He is asking for having these but people shall not feel the need of using these. There is no doubt about the weapon use. About boats, Lao Tzu is not asking for abandoning (doing) them because he is not a person to enforce doing something. He is a believer of the happening. Actually in this verse, he is mentioning the signs of an ideal state. First, state does not exist on its own i.e. it does not have any consciousness or collective consciousness. So contentment and enjoyment at individual level of what one is having is the first pre-condition of an ideal state. Hence, people should first enjoy their current state. If they do not like their home, their city then there is no value in going for a vacation travelling afar. Lao Tzu does not see any value in this…for him this is not ideal. He is not abstaining from travelling but first one should make his home an ideal place for living.

 I know many people who have left farming for a job in big cities where they are living a very nasty life…in crowded places, terrible pollution and traffic. And then they go back to their villages or hill stations for taking a break for this nasty life. Lao Tzu does not advocate this nonsense life just to earn more money. We can enjoy 10-20 days vacations in our village but we can enjoy this forever if we leave our greed for money and name. If we can see, we all want to go to Switzerland, hills, sea shore and forests because we do not derive happiness from our present way of life. We show other people that we are successful with all our money but deep inside only we feel the void…there is no real happiness. Lau Tzu knows that happiness is not relative just like most of our things (truths) are…happiness is not relative to the views of other people about me. Lao Tzu knows that it originates from our within…from our actions only for ourselves. So Lao Tzu wants people not to be guided and motivated by money and social success because there is no end to this greed.

Remember Lao Tzu belonged to a period which is almost dated back 2700 years so one just can’t juxtapose his words into present physical world and declare him anti-growth. His physical world was different from our world but much advanced from Stone Age. So Lao Tzu could have told to go back to Stone Age nomadic life but he had not. He had not asked people to wear clothes made of skin or tree leaves. He was saddened not by the growth in physical world but by the moral decay of humans at that time due to excessive greed and longing for physical life avoiding simplicity and natural harmony. So when he tells for doing labor with hands in farms, one can’t conclude that Lao Tzu would have wanted the same thing at present. He just wants people to involve in physical work because even now we all have realized how our sedentary life style has created havoc with our health by giving rise to dreaded life style diseases like Diabetes and BP.

In our quest for physical growth, we have destroyed and polluted nature and natural resources at massive scale. And without any further explanations, we all know that we are over-doing our lives for long time and we have destroyed everything which can turn this earth into a Utopia.

Lao Tzu- The wise old man

Lao Tzu was the greatest thing that happened with China but drifting away from the path of Lao Tzu was the biggest mistake committed by China. Lao Tzu (which means wise old man in Chinese) was the father of Taoism (Daoism in Chinese) in china. He summarized his experiences and views on how to live a perfect balanced life in harmony with nature in his book “Tao Te Ching”. If you ask me, Lao Tzu was rare among all the mystics ever born onto this earth. Quite unlike most others, Lao Tzu found that the life on earth can really be worthy, having purpose and true happiness. He did not denounce this life by regarding it as worthless but a chance to experience blissfulness during this short journey on this earth. But what we regard as happiness is the first on the list of Lao Tzu which according to him makes our life miserable and worthless. Main reason- our happiness is in the eyes of others and to make matter worst these eyes value gold more than the experience. We value what others think about ourselves not what we want to do for ourselves and as this is happening for ages we take this as part of our life…we never question this nonsense. We think that this is the only “way” to live this life- the way which only makes our life miserable…it is only about for how long our bodies can tolerate this nonsense which we regard as life. That’s why the likes of Lao Tzu had to come forward to show us the correct path, the Tao. Tao means “the way”.












As per the legends, Lao Tzu was eighty years old when he retired feeling extreme sadness by seeing people living life full of corruption, hatred and misery in complete isolation from the path of natural goodness. Lao Tzu lived in modern day Tibet around 606 to 530 B.C and before leaving the place forever he was requested by one of his friend who was the custom officer to write his teachings which resulted in this wonderful book- Tao Te Ching and perhaps this has been the most translated book after The Bible and The Gita. But still I think that most of these efforts have still failed to catch the glimpse of the soul of Lao Tzu, the Tao. I think he is one of the least understood mystics. I often hear that he was a great philosopher. But I do not think that he was a Philosopher…Philosophy does not require experience…it is the vision of the mind….contemplation. And Spiritualism begins at the fall of mind. Lao Tzu was a spiritual man (not religious)…a true mystic who felt the divine forces governing life and most of all been able to express it in most subtle way.

I think this misinformation about Lao Tzu stems from the fact that his masterpiece “Tao Te Ching” does not talk about God, his personality or his reasons for creating this world. But that’s exactly why I found this book rare…a true masterpiece. The Great Lao Tzu talks of life on this earth. Tao Te Ching is about man not superman (God). Lao Tzu was able to observe the universal law behind all the forces of nature and this book talks of this law with reference to man’s life not about the nature and origin of this universal law. It just accepts the presence of this law and then moves forward to assess its relationship with the happiness of human beings.

But the language used by Lao Tzu is pure magic. It is unimaginable that he could understand the nature of universe with such perfection 2700 years ago and most of it he could express the same in human language in most perfect way. When you read this book…in every Verse you can feel the presence of quantum mechanics. Derivation of non-dualism from dualism (Yin and Yang) is unimaginable. Lao Tzu looks like a person living for thousand years…fought countless wars and recognizes every grain of sand on this earth.  Most people take China as a land devoid of any religion but if you ask me then Taoism is the most advanced religion in the world. Buddhism is very similar to Taoism and that’s why it could spread to Far East after it left India.

After Lao Tzu, it was the great Chuang-tzu (Zhuang Zhou) who carried forward the Taoism to great heights. People doubt on the existence of Lao Tzu but Chuang Tzu did happen and he was the man of massive wisdom. It was because of Chuang Tzu that Buddhism is transformed into another unique religion in China/japan- Zen.

What is the Path of Lao Tzu-The TAO

But what is this Tao? Lao Tzu was a very keen observer of the nature. He watched trees, breeze blowing, the warmth of sun, flowing river. Very soon he realized that except human beings nothing strives (please note strive is more aggressive than doing or wanting) for power and fame. Things are just “are”…there is no attempt to break the natural harmony. Lao Tzu was quick to understand that this madness and hunger for power and money is the root cause of all the misery of humanity. Instead of being happy at what we have naturally; human beings want to grasp more and more just to earn the jealousy (not praise and value as we think) of others. Like when i compose music or draw a painting I do not feel happiness at this great piece of creation because I want to create a great noise for my creation…to earn money and name…nothing else. It was a shock for the people like Lao Tzu that how someone can’t feel happiness at his creation and quite contrary he feels happy only when his creation is rewarded with money and fame…otherwise he feels miserable.

I have seen many creative persons who are always full of despair and emptiness because they could not earn name, fame and money with their art. They were always taught the value of money and name since their birth and they believed this to such an extent that they just can’t enjoy the gift of creativity given by Mother Nature to them. If they have the eyes they should see that they are the chosen ones because I have always felt that creativity is the best way to feel happiness….in fact extreme happiness. In fact not just happiness but feeling close to Almighty because if you ask any creative person how he creates music or draw a great painting or a great story then he can vouch that in some sacred moments these creations unfold onto them from somewhere. But it is shocking that these fellows can’t value and feel the bliss at these rare moments when Mother Nature visits them.

I know a person who has been blessed with a great voice (for singing) by Mother Nature but due to some reasons that he couldn’t touch the heights of name and fame and I have always seen him miserable in all his life. He could not enjoy his own singing because he strived for name in the society…the only aim was to rise high in the eyes of others. So in place of feeling bliss at this amazing capability he has wasted his life so far in grief. And if you ask me singing and music is amazing…it is the language of emotions…best way to express joy and pain. When you sing or hear music the sound resonates with something in you (Vedas say “Shabdaikagunamakasham” which means that Shabad (Sound) is the guna (Property) of Akasha) and you become a sound only….time disappears…eyes stand still…hours pass like minutes. I told him to start teaching a small group and enjoy but he does not want a small group of people to know him, value him…he wants the entire sky.
For Lao Tzu, this is not the way to live life…this is not natural. Happiness and peace for Lao Tzu come from one’s within and do not depend upon worldly success and wealth. Lao Tzu wants people to observe nature to understand how all the things in nature follows the natural path…natural law which guides all the things in this entire universe…the Tao.

Taoism: A cosmic interplay of opposites

Lao Tzu’s Tao is about the universal law…the nature of reality…the regulation which holds together entire universe…all the existence…and everything. That’s why lao Tzu tells that Tao existed before everything. The most remarkable thing about Taoism is that there is not personified God…they just talk about the universal regulation. And this is why Taoism is so special. Almost all mystics have talked about, described the Supreme Being called God in their writings or teachings. They have tried to personified him for our understandings and if we can see this has created so much of religious anarchism among humans because all have tried to declare that their God (personification) is most authentic.

But if you ask me then this non-personification is the biggest contribution of Taoism to the mankind. But why non-personification? Just see what Lao Tzu says:

Verse1: The Tao that can be told is not the eternal Tao. The name that can be named is not the eternal name. (Just look at the poetic beauty of this…wisdom…just incredible…I read this and I have teary eyes)

Verse 2: All can see beauty as beauty only because there is ugliness.
All can know good as good only because there is evil.
Being and nonbeing produce each other. The difficult is born in the easy.
Long is defined by short, the high by the low. Before and after go along with each other.
So the sage lives openly with apparent duality and paradoxical unity.
The sage can act without effort and teach without words.

Lao Tzu understands the inherent limitations of our language and senses. That’s why he refrains from using words for the ultimate doctrine because of the limitations of our language this can lead to very wrong interpretations. Our words/truths are relative…relative to the point of reference and they are defined by opposites. Truth is not defined or confined by time and space…truth is absolute When we say good then this points towards existence of bad also.

The great PD Ouspensky in his book “The Tertium Organum” (one of the best books I have ever read and will ever read) explains:
“We cannot define one unknown by means of another unknown. The result is nothing but the identity of two unknowns: x = y, y = x.
Matter is that in which the changes called motion take place: and motion is those changes which take place in matter”.

And you realize the relativity of our facts and concepts. Our words are incomplete and hollow. Like health…we do not have any positive or independent definition of health. It says health is when we do not have any disease/illness so health is defined by the opposite (although I feel health is when we do not feel our bodies…so light). So when we say someone is healthy then that also means illness.

That’s why lord Buddha became silent when asked about God. Some says he denied God but he had not…he was silent and silence does not mean denial. He was silent because of stupidity of human beings. This earth has seen countless enlightened beings who have tried hard to make us understand the nature of supreme existence so that we can see the meaninglessness and worthlessness of life we are living. But just look at the following what we have understood so far about the supreme existence or God:

Our God wants us to acknowledge his gratitude for giving us this life and so he seeks submission and continuous songs/reciting of praise. And when we drift away or avoid his pre-described path or directions he cursed us with sufferings in hell.

This is what we have made of him…only in the image of human  being…and this is what precisely the essence of religion for most of the humanity. To be a follower of this type of religion one only needs one thing- Low IQ. It is not surprising that most of these so called religious people have low IQ. These are the religious people who feel content just by offering a thing or words as prayer, who feel being religious will end all their worldly problems, who feel just by listening verses, by fasting they are touching the supreme divine. You will not see any sort of religion in their eyes, their actions…they indulge in all type of nonsense but they think they are religious. In fact, they do not have their religion by their choice. They are born into it.

But this happens when we have a personified God who is kind and desires for our happiness. So I can offer one coconut or flowers or fasting for twice a week and I will be delighted that I have made God aware of my religiousness and he’ll take care of me. It is shameful that we still seek the world from religion. But if you go near a person like Buddha or Lao Tzu they will first of all destroy the world for you so that you can see the real world beyond. They will not do this in most pleasing way; in fact they will kill you and your ego.

If you ask me about God and religion, then creativity is the thing which takes us near to the supreme divinity. When Supreme created this universe, he had done the greatest piece of creativity. So when we create something- a new music, new piece of an art, new invention...every new creation is his mirror image, his idea of being in bliss, his idea of purpose, happiness and Joy. We are moving ahead the wave started by him...the realm of creation. That’s why creative people are rare. That’s why creative people always feel that in their creation they are guided by the divine. Every new song, new painting, new story, new idea is an addition to this world.every song is unique...not created before.That’s why the world value creativity so dearly. So being creative and by creating something new we are worshiping the Supreme in reality. At times, creative people looks eccentric but they are the happiest if guided properly to not to seek money and fame. That’s why I have always felt that an ideal society will motivate and support the creativity.

That’s why I feel for today’s world, Lao Tzu is the person to follow.


















Lao Tzu sees the perfect harmony in opposites…it is the inherent design of nature….unity of opposites. It shows that the visible separate or opposite systems are united and one can’t exist without the other. Universe is one single cosmic event or existence but it is human who differentiates between life and death, old and young, good and bad, male and female energy, light and darkness, joy and sorrow because they can’t see the oneness of the existence. The opposite forces do not kill each other but they are complementary forces balancing the life for its nurturing. So those who understand the Tao and paradoxical forces of life they know that due to very nature of life being balanced out by opposing forces so there will be good and bad times but the follower of Tao does not try to avoid this but he accepts this as part of life and by doing so he transcends this. This is most basic teaching of Taoism- the Yin and Yang symbol.

Lao Tzu observes that this unity of opposites exist in both natural and human world. Love and hate coexists. Happiness and grief coexists. For example, I love my beloved and this feeling of love gives me great happiness and joy but in the end one day she will be dead or she would leave me for someone else and this will turn all the happiness into pain and all the love into hatred (if she leaves me). But Lao Tzu tells us to accept this as nature of phenomenon as it follows the universal Tao of balance in opposites.




(Yin and Yang)











One day, a young man was telling me about himself and he claimed that he is very brave and has no fear. I told him that actually a brave man does not know that he is brave. He is just “what he is” and when someone says he is brave than that means he also has his share of fear. I asked him a question about three persons who on a dark night visited a haunted graveyard. One person believes in Ghosts but still he went to the graveyard. Second fellow does not believe in ghosts (but he knows the concept) but still he went and the third does not even know the concept of ghosts and he also went to the graveyard. Now tell me who among three is brave or bravest of three? This is paradoxical life. And if we can see the first & second fellows are brave but they have the element of fear in them but the third fellow is not having any fear at all but whether he is brave or not?? I leave this to readers. But if we can see nature- the lion who is the king is very brave but still he also has the element of fear in himself. Sometimes an angry buffalo makes him run. This fear is necessary for his survival. So if we can see then fear is the Yin and courage is the yang. Courage is not the “absence of fear” but acting on the face of your fear. But a lion is never good or bad, a human being is. So the courage can make a good human die for the cause of highest good.

In many commentaries on Tao Te Ching, I have seen authors explaining this unity in paradoxes (verse 2) that Lao Tzu wants us to see the contradictions in life and wants us to avoid any action on these opposites like Lao Tzu will not take any “action” when he loves somebody; he won’t tell that person that Lao Tzu loves him because love will “lead” to hatred in the end. Lao Tzu will be silent. First, I do not think that telling somebody that I love him is “action” and falling in love is not. Love has already happened but it coexists with hate. But not telling love is not the way of Tao.  Lao Tzu is not denying the opposites that if you say love then hate will come. No. He is just saying that both these coexist just like all the things in our life and nature…they are balanced by opposites. So we should accept them just as they are in whole. No need for any action in denial of this. This is the meaning of Lao Tzu when he says that sage manage affairs without action…it is the innate nature of Tao.

I need to stop here because Taoism is so vast that it is not possible to cover the entire vision here.

Covid-19 has given us a perspective to stop and look back

In our quest for growth in the form of money and power we have wreaked havoc on this earth and destroyed so much of delicate ecosystem. Every country wants GDP growth and so they are just tearing earth for minerals, cutting forests, polluting rivers, making public consume more and more. The end result of this nonsense is our devastated lives and highly polluted cities and rivers. If you ask Lao Tzu then he would say that human has tried to hit the balance of yin and yang and so earth will take its action.

Sometimes back, I was sharing this with my wife that mother earth is a living being and it is not possible that “they” (the creators) will leave the destiny of earth in the hands of foolish human beings so we may see some “cleansing” action from mother earth and that can bring devastation and chaos in our lives. But now with the onslaught of Covid-19, I think nature has given us a chance to sit back and observe the peace prevailing in our lives and at earth these days. Cities are having fresh clear air…pollution levels are reducing greatly. This covid crisis is going to phase out soon but I really hope and pray that this will give us much more in the form of understanding the importance of living in harmony with mother earth and importance of simplicity and contentment in our life.

I hope that this will serve as a perspective for us to bring necessary changes in our view towards growth. First change which I feel we need is to include balance sheet in our calculation of GDP growth. In our GDP calculations we only have profit & loss account where we measure the goods and services produced in a given period of time. But we never account for the damage inflicted by our GDP growth actions on environment i.e. deforestation, soil degradation, air and water pollution. These natural resources are part of natural capital which is most important for any sort of productive activities. We can’t run our factories alone on machines and labor. These factories needs air, water, soil, forests etc….everything we regard as natural resources. All these natural resources are vital for our existence, so if I destroy a forest and extracts iron ore from it we add this iron ore to GDP but we never deduct the damage caused to Natural capital by this activity which is as real as iron ore. So if we inflict any permanent damage to this natural capital then the same should be reduced from the total goods/services produced. Hence our GDP figures are overstated. And unless we design a way to calculate this damage we will never understand the value of Natural capital. So we need to have a balance sheet of an economy comprising Natural Capital (its value will be massive…no doubt) and any diminution in the value of this natural capital should be adjusted against National Income account to present the true state of our economic activities.

I am not surprised to see economists declaring the onslaught of global recession. But I think recession is much more fundamental than fall in GDP rates alone. Recession is about significant misallocation of productive resources whose course correction is not possible in short term. Like a country, where massive resources have been put for manufacture of Automobiles (for local and exports) and then all of a sudden there is global oil scarcity due to peak oil and oil prices shoot up which hit the demand for automobiles very hard. In this situation, it is very hard to do a fast course correction by creating new product manufacturing centers and also absorbing the massive loss of automobile capacity.

If we can see the situation now, after Covid-19 crisis there are high chances that people may not go to cinemas, amusement parks, Tourism, restaurants or even shared taxis (ola/uber)….i mean all public places. But whether this curtailment of demand for these products will be permanent? Actually, the crowd is not only at cinemas or restaurants alone. It is and will be everywhere- whether it is schools/colleges, factories, sports events, hospitals, businessmen going for air and railway travel. So avoidance of crowded means stoppage of all and everything. But deep inside we all understand that this is not going to happen so similarly there is a chance that when factories, schools etc. will be opened first then the same will dissipate the fear of crowded places gradually and this demand curtailment of cinemas etc. may not be permanent. Even at the times of Spanish flu in 1918-20 cinemas etc. were survived. So we’ll see this recession fear in detail in the next post as this post is only for the reverence of the great Lao Tzu.

Thursday, 27 February 2020

Clariant Chemicals and BASF India-Updates And Why EBITDA is used for Valuation


Clariant chemicals ran up decently to 440 from 275 when it was advised last time in Nov-2019 (Click here for old post). At that time it was expected to sell its Masterbatches and Pigments business to focus more on high margin specialty chemicals business. I was expecting to sell the same at anywhere around 1500 cr to 2000 cr valuation excluding land bank which was around 15 times its last year EBITDA and around 1.5 times to 2 times of the turnover of 1000 cr while it was available at just .6 times of turnover. So the valuation discount was massive.

And it finalized the deal in dec-19 to sell its Masterbatches business to PolyOne for Rs. 426 cr. Global parent Clariant has entered into two transactions with Polyone-first it sold its global business for Swiss $ 1.56 billion which is 12 times its EBITDA. Then it also sold its Indian business (as it is listed separately and parent has 51% share) to Polyone for 426 cr which is around 17 times its previous year EBITDA just as per our expectations. The turnover of Masterbatches business was 284 cr so it got the valuations of 1.5 times of turnover. The proceeds will be used to invest in innovative and technically superior products, to give dividends to shareholders. At parent level they have plans to retrun back some $1 billion (almost 60%) as dividends so we can expect the same in India also. If after tax proceeds in India are 350-380 cr then we can expect some 200 cr as dividends which is around Rs. 90-100 per share. This is from the sale of Masterbatches business and Clariant is expected to sell its pigments business also by the end of 2020. Its Pigment business in India is much bigger than Masterbatches and so we can hope for another big dividend this year. Sale of masterbacthes business is expected to be closed by Mar-2020.

Clariant is going to concentrate on three core Business Areas Care Chemicals, Catalysis and Natural Resources and I think they will do the same in India also. After the sale of pigments and Masterbatches, Clariant is focusing on chemicals for consumer products likes soaps and shampoos, the oil and gas industry, and catalysts that help speed up chemical reactions.

Clariant Dec-19 results

After the result of Dec-19 quarter, clariant has fallen to 340 levels all the way from 460-470. I think perhaps market misunderstood the results of clariant chemicals. It was not that bad as they are looking. It has shown a loss before tax of 3 cr this quarter but the same is due to the impact of showing of masterbatches business under discontinued operations. As they have entered into an agreement to sell the same so the performance of this segment is shown under discontinued operations and if we add the same into the normal business then the figures will start to look much better:
(Figures in Rs. Cr)
Dec-19
Dec-18
Continuous business Turnover
188.33
171.09
Add: Discontinued business Turnover
91.75
78.83
Total Turnover
280.08
249.92
PBT
3.25
-3.53
PBT after adding outgo of 1.36 cr on tax amnesty scheme
4.61
-3.53
     
Further this year they have opted for amnesty schemes of various state and central governments in respect of outstanding indirect tax litigations and paid around 10cr this year otherwise the figure of profit of 9 months this year would have been higher by 10 cr (45 cr vs 10 cr up to Dec-19). The expenditure under this head in Dec-19 quarter is 1.36 cr.

I think this one is a great buy at 340.

BASF India: Another gem at massive discount

In the same post on clariant in Nov-19 (click here), I have also mentioned the great prospectus of BASF India as the same was also looking to sell its construction chemicals business to focus on speciality chemicals business. Earlier, BASF has also sold its pigments business for euro 1.5 billion to Japanese chemical giant DIC in order to focus on new age specialty chemicals. In dec-19, BASF has entered into an agreement with Lone star which is a global private equity player to sell its construction chemicals business for $3.52 billion (around Rs 25,000 crore). So the same is also being divested from Indian arm also. Its indian construction chemicals business has been sold for Rs. 595 cr which is having turnover of Rs. 484 cr so the valuation is 1.2 times of turnover. Its global business is having revenues of $2.5 billion so at transaction value of $3.52 billion the valuation is 1.4 times of turnover.

So taking 1.2 times as the basis- total turnover of BASF India is around 8000 cr so it should be valued around 10000 cr although its remaining specialty chemicals business is of higher margin business. Right now at current market price of 900 it is valued at just 4000 cr which shows the gross undervaluation.

BASF expanded in construction chemicals in 2006 but it has struggled to build the scale in this complex sector since local construction techniques can differ even from country to country. So this unit was not the star performer for BASF and that’s why I think the rest of the businesses of BASF are much more valuable.

Its results in Dec-19 quarter were great. Its topline has grown to Rs. 2000 cr from 1400 cr last year but I am surprised that market is caring more for profits when scale and market share is more important in chemical sector. BASF India is having minor losses due to high raw material costs but it happens due to product differentiation and it being predominately a specialty chemical player while most of Indian chemical companies are commodity or basic chemicals companies. Its raw material prices are high and it is trying to lower the same. Another listed indian player Aarti industries trades at valuation of 4 times of its revenue only due to low raw material costs although Aarti is mainly a commodity chemical player. Its turnover is around 4000 cr and it trades at 17000 cr market cap. Aarti's raw material costs are 60% of turnover whereas the same are 80% for BASF. So one can assess the scope of growth for BASF with turnover of 8000 cr and it just need to solve the raw material equation. Higher oil prices and currency fluctuations are the main issues hitting its raw material costs as it sources the same from group companies across the globe.

BASF has made significant investments in China. Recently it has planned for $10 billion investment in China for engineering plastics and thermoplastic polyurethane (TPU) and first unit has started production. Very few knows that BASF is a significant player in electric vehicle battery segment (Cathode material) and global electric, electronics and automotive players look towards BASF for the innovative solutions. Its indian investments are not that high but recently it has upped the ante in india and announces a mega JV with the likes of Adani to start a Rs. 16000 cr chemicals plant in India. Its turnover in china is $8 billion whereas the same in India is around $1 billion. But it has invested big in India in last 5-6 years as compared to last 100 years so as India is going to be the global hub for chemicals I have no doubt that BASF is going to increase the investments in India big time.

BASF is one of the best chemical player in the world and have several innovations to its credit including supply chain. Supply chain plays a major role in chemical sector because quality plays a lesser role in affecting sales. The major factors which affect the chemical sector are price, volume, currency and portfolio of products. So raw material costs and supply chain efficiency are the major factors which drive the profits. BASF is only company from chemical sector which is counted amongst the global best in most innovative supply chain.

BASF has one of the most innovative and advanced constructed supply chain where the byproducts of one operation get converted into starting materials of another operation. In Germany they call this concept “Verbund”. When by-products of one plant can be used as the starting materials for another, chemical processes consume less energy, produce higher product yields and conserve resources.

The Ludwigshafen site of BASF having an area of ten square kilometers, is the largest chemical complex in the world where 110 production facilities and 200 production plants are interconnected. Byproducts and products flow through 2850 kilometers of pipes, 230 kilometers of rail, and over 100 kilometers of road. An astounding 39,000 employees work at this site. On its six Verbund sites across the global, BASF achieves annual savings of more than $ 1 billion through its Verbund.
So BASF is a great buy at CMP of 900.

Reason for recent M&A activity in Chemical sector

I have covered some details as to why the likes of Clariant and BASF are divesting some of their chemical business in the last post in Nov-19 (click here). Actually as I have shared in chemical sector raw material and supply chain create the biggest space for margins hence size matters in this sector so over time what happens is that all the companies try for the capacity expansions which result in the excess supply in the sector. The only way to absorb this excess supply is to acquire capacities and then merge or align the same with your existing business because if one company plans for shutting down one of its existing facilities due to excess capacity the same is going to benefit the rivals the most because this will lead to lesser supply. For growing scale and margins, it is easier for companies to shut down plants of much larger entity formed after acquisition of rival capacities and by keeping the most productive plants with best raw material linkages and supply chain.

So M&A in chemical industry creates the value for buyers but as in M&A most of the value accrues to seller and that’s why I think both clariant and BASF have got good prices for their divestments. And if we can see, when both the buyer and seller are fighting for getting the synergy and benefit out of sale, the other players in the industry who have done nothing are also going to gain from this transaction as this will reduce the overall capacity in the industry. This is very complex set of creativity and planning and that’s why sometimes I say that businesses are just like creation of a piece of an art like a painting or music.

Further, as there is general slowdown in the global economy so demand is low for chemicals also and they are growing at 2-3%. So many global players have increased their focus on mergers and acquisitions in order to create the scope for growth, realize cost and revenue synergies, and enhance their product basket and their value proposition to the customer.

EBITDA for Valuation of Business

Many readers have asked me why EBITDA is used for valuation rather than PE especially while acquiring businesses. First of all, there is not a perfect valuation of a business. Valuations are always subjective (50% subjectivity) and extreme hard work, capability and vision is required to make acquisitions work. Hence, most of the times (99%) selling firm shareholders derive most of the benefit not the buying firm.

If one can see, accounting these days has become so complex that it has lost its utility for valuation of business. There is huge involvement of complex accounting treatment of various business entities along with subjectivity in using or assuming accounting policies. I always say that profit we see in the books of account is mainly accounting profit not business profit. The books of accounts primarily serve the purpose for taxation or accounting profit and loss figures. Apart from this, another important factor is the presence of situational or positional factor at a particular point of time for an organization which are unique to that organization only and these factors may have no or  different presence for the entity who is acquiring the business.

So if we can see that the profit of an organization is derived after accounting for some factors which are unique for that organization only and for the buying entity it is necessary to eliminate these individual factors in order to arrive at figure of profit which is more general and realistic. Like, for example, depreciation has a big impact on the profits of a manufacturing organization but depreciation charge depends upon the age of machines. So if there are two firms with same topline, say 1000 cr, but as one firm has installed new machinery its depreciation charge is much higher at 100 cr while the other one has much lower depreciation charge of 30 cr due to old machines. So as we can see, for same turnover ,almost same raw material and employee costs the profit of new machine firm will be much lower than the other. So this situational factor will change the profit figure significantly without affecting the business performance or profits. Same is the impact of tax rates and leverage (interest costs due to debt/loan while other may have higher equity and nil debt). The selling firm may have higher interest costs due to lower credit rating while the buyer firm may have much higher credit rating so it can keep the same level of debt although at much lower interest cost.
So the buying firm may have very different capital structure, tax rates or different asset base which necessitates it to have a more realistic evaluation of performance of the selling firm by eliminating these individual factors. So EBITDA figure is the contribution from the business irrespective of the asset base, capital structure or tax rate. In other words, it is more generalized version of the performance. Firm specific factors color the real performance but as the firm is being sold to another firm so selling firm specific factors will no more color the performance in the future so it is necessary to eliminate their impact.

Further, EBITDA valuations provide the enterprise value (EV) of a firm which means that this value also includes debt in it as interest is also included in EBITDA figure. So in order to arrive at shareholder's stake value we need to deduct the quantum of debt from Enterprise value.

Using Net profit (PE ratio) as a base for acquisition will give very misleading results and may spoil the game for a potential bidder. Net profit figure is arrived after accounting for all the complex accounting and taxation laws and firm specific capital and asset structure which will distort the real performance indicators. I have almost stopped using PE ratio while doing the analysis long time back. Many times I don’t even look at the Net profit or EPS figure. This is just like small children are taught in school. “A’ for apple is only used to make them understand the sound of A not apple. As their understanding grows, they can make new words with A. Similarly, PE is just “A” for apple and it is not the only metric to judge the performance of a company. It is just the starting point.

DCF-Any Merit?

I do not have much liking for DCF (discounted cash flow) method for valuation of business although the same is used widely and in fact in many research papers I have seen authors arguing in favour of DCF and heavily criticizing EBITDA method. Actually, one thing which I find worth mentioning is that there is not any perfect objective formula or method to evaluate businesses and one reason for the same is uniqueness of every business. So, two firms can have same figures of top line and bottom line but with different modes of operations like one is outsourcing entire manufacturing (asset light like Bajaj electricals) while the other may be having its own manufacturing capacities, assets etc. So customization is required at every stage. Further, the fact that most of M&A fails is a testimony to the wrong price discovered and paid (still DCF is used widely, recently for valuation of defense arm of Tata power, Tata Power SED, PWC has used DCF method valuing the firm at 1780 cr) and shows the limitations of any linear method in the valuation.

DCF- one very important problem which I find in DCF is that it tries to value the future business performance but if we can see what we are getting is “what the previous owner has done/created in business till date”.  so past performance should be the basis for evaluation not future. Past profits are what the previous owner has achieved. This is just like we are getting a chicken but as we want to make Bar be que chicken in the future so we are ready to pay the price of Barbequed chicken!! I think that DCF over-value a business and buyers end at paying much higher price. Second, DCF requires too much guesswork with regard to everything. If we leave alone the complexities in assessing the future cash flows for next 10-15 years (which requires estimating the growth rate etc.) still even the estimation of discount rate is very complex. Discount rate requires estimation of interest rates, inflation rates etc. which I think even best economists, central banks across the globe has never been able to forecast even with 50% accuracy. In DCF future forecasting for cash flows there is never a bad year or down year…all the time there are positive cash flows which I find hard to believe. Industries and businesses go through periodic variability every now and then. Then there is complexity in assessing the terminal growth rate.

 So amid so much melodrama, I am surprised how people can have any sort of confidence in the valuation figure we get from DCF. In the end, DCF fails to offer any practical value (in my view)…but still it has immense theoretical and conceptual value because even in other valuation methods the inherent logic is the cash flows. It is surprising that even after 300-400 years of equity markets we are yet to develop a workable real life business valuation formula…even 70% accuracy is more than enough.

But still, DCF can offer valuable insights when valuing annuity type of business. Like, that day I was checking Mukta arts ltd which has a library of some 30-35 films (some of the most hit hindi movies like Karz, Khalnayak, Saudagar, Pardes,Ram lakhan etc.). Mukta arts is selling the rights of their 35-40 movies for some 60 cr for 5-6 years which means that yearly cash inflow is some 10 cr…after tax is around 7-8 cr and as this require zero maintenance (as compared to commercial lease/real estate) so 7%-8% is good risk adjusted return for this one which makes the minimum value of this content assets at some 80-90 cr and this is the current market value of Mukta arts!!! But apart from this library, they have much valuable business in the form of India’s best media university (Whistling woods international, revenue 50 cr High margin) and their cinema brand A2 cinema (revenue 100 cr mostly share of revenue/advertisement with 65 screens), they have 2 properties in Bandra valued some 40-50 cr, they have high growth content production business after the onslaught of OTT. The movie rights were sold for some 40 cr 3-4 years back…so instead of depreciation the value of these assets kept on increases. And they are carried at Nil value in the books.

I am not saying that Mukta arts is worthy of investment but still it looks much undervalued. As we can see, in annuities types of business DCF will have its worth like lease rentals firms.

Once one of my friend explained a case to me to show the fallacy of EBITDA valuation. He studied the same in many research papers and articles proving the worthiness of DCF and fallacy of EBITDA. In those articles, authors have given an example where two companies of the same size have different levels of EBITDA- one (A) has 35% EBITDA margins while the other (B) has 30% so one can say that A is better and should be valued more as per EBITDA. But then they revealed that firm A has invested massive sum (1000 cr) for expansion while B has spent some 200 cr for repair etc. of old plant and machinery. So if one can look at 1000 cr investments then B is more valuable because the ROE of B will be much higher than A.

But i think there are some most basic flaws in the estimation work and because it is estimation so one can prove it any way. First of all, I find it hard to believe that a firm with 1000 cr assets is only having 5% more EBITDA margins than firm with 200 cr assets…I mean firm A should have massive depreciation charge and that should raise EBITDA to very high levels as compared to B. Then, EBITDA is not a gun in the hands of a child who can shoot anything. If both the assets have same age then it is so foolish on the part of firm A to invest 1000 cr just to earn 5% more by putting 5 times more….but why a business will be so foolish? We know it is not the case…we need to treat businessman as rational while taking hypothetical cases…we can’t imagine one man as fool and then reach at some rational conclusion.

So if firm A is rational than it means that assets of A are much more valuable and will last much longer and this is where the difference will arise. People try to present EBITDA as one tool which does not care for the age difference of assets and cost of capital. But I think this is gross miscalculation because in EBITDA valuation, EBITDA is just one of the variables…it is not the entire universe. Because the second very important variable is the “valuation multiple” and if you ask me this multiple is affected by the age difference of assets and cost of capital. Firms with much costlier, advanced and new assets get higher valuation multiple. But still this depends upon the industry we are dealing with like branded FMCG has lesser impact of production assets because maximum value is derived by the Brand strength of the company and people buy their products even if they are costlier than the competition. So there may be a case where one firm with large assets (firm A) is compared to same size firm with outsourcing model (firm B). If we take all other factors affecting profits as equal then firm A should have higher EBITDA because the firm B will have higher cost of production because in any case the assets are created by third party manufacturer who will charge the same to the firm B in production cost as overheads besides direct costs. So as we can see, firm A EBITDA will return profits in the shape of depreciation for financing the future investments for expansions or replacement.


I can’t believe that two hospital chains-where one is having its own hospital buildings and other is having leased assets- can have same (or little difference) EBITDA levels (let’s ignore IND AS 116 on lease accounting for time being) because lease rent will be charged as expense and will not be a part of EBITDA while owned assets will retain a part of profits in EBITDA figure as depreciation. So EBITDA of asset firm will be higher and when multiplied by the valuation multiple the difference will be significant.

Turnover for Business valuation

Further, EBITDA has different implications for different set of buyers. Like, if a new player is buying the business (like a Private equity firm) EBIDTA will be more relevant for him. But for a firm which is also into same line of business then the turnover figure will be more relevant as they may have their own raw material sourcing at lower costs, different organizational structure resulting in low employee cost etc. They will also get the positive synergy impact after merging the both businesses due to lower administrative costs, common IT costs, efficiency in sourcing of raw material, lower supply chain costs as it can leverage its present supply chain much better. So many times instead of EBITDA, turnover figure is used because this is the figure where there is no impact of subjectivity and individual factors. Further, there is very less scope of play (not fraud) with turnover figure like depreciation rates etc. So due to these reasons many times turnover figure is taken as basis for valuation especially in case of brands because due to brand strength turnover figure will not have much variations and this will be stable for the most of foreseeable future like Maggi noodles.

But turnover as a basis for business valuation is not used frequently although I find it a very valid method and I use this quite often. In my view, this is best suited for businesses which are operating in mature markets (mature does not mean saturated but maturity related to information and demand and supply of the product), high margin products so that there is not much complexity involved in calculating the impact of factors like raw material, labour and energy costs because in low margin product businesses any significant move in the cost factors can drastically change the business performance hence turnover alone can’t be the basis of business evaluation here. Then comes the market share- firms with high market share in the mature markets. Further, high margins businesses often do not need to offer large credit to distributors/retailers so if we can see the factors which can affect the margins coming out of topline figure are very less in high margin businesses due to high entry barriers in the forms of technology, monopoly or brand strength hence turnover figure alone can represent the true worth of the business. Like, in services business it is very easy to use this metric as it satisfies the conditions of high margins and lesser impact of cost factors (IT industry).

So many times I use both EBITDA and turnover based valuation methods for the valuation of a stock as both give valuable insights. Still, EBITDA and turnover are just the base materials and the major complexity is in the deciding the valuation multiple- whether the same should be 15 times or 20 times of EBITDA or 1 time of turnover.  

I have done some work on valuations multiples and want to write more on this with more real life examples but for the time being due to length of this article I am leaving it here. I’ll take up this valuation exercise in detail in some other post.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post).


Wednesday, 8 January 2020

GST Issues: Denial of ITC related to construction of Enabling works/PEB storage sheds by treating these as Immovable property


(This is the first article on GST in this Blog and it may not be that relevant for a non GST professional. So I have divided the article in two parts- first part is general discussion about taxes which I think is relevant for everybody and second part is specific to the GST issue but even in this part the views about immovable property are relevant even for a non GST professional)

PART-1-General discussion about Taxation

Tax laws should be simple

If we keep ourselves aside then objectively, on its own, life does not seem to have any higher purpose….except reproduction. Everything around us- whether a flower, an animal or an insect…everybody is just seemed to have one motive and that is to reproduce before death. Life- if one can see appears to support and favors reproduction only not anything else. It does not care if a poor baby is being killed or an innocent girl is being raped…no law of life intervenes…nothing. We may be having larger than life aspirations from our short term life here but life does not seem to expect much from us. But still, all this massive universe and gigantic phenomenon couldn’t have been planned just for creating this worthless cycle of birth and death. There must be some higher purpose behind so much pain and plan in creation. But by looking at the relentless focus of life and support system mainly upon reproduction- it seems that the life system still has deficiencies and its design (like short life) is not fully supporting the basic purpose behind the creation. Or we are living in a Tier 3 world with a chance to upgrade into higher dimension world.

Taxation is a nightmare for most of the humanity. The language used to draft the tax laws is a nightmare even for the highly educated fellows. we see extremely talented professionals debating in courts over tax disputes where we see that the cases involving tax disputes of hundreds of crores are settled by courts over the interpretation of phrases like “in respect of”, “in relation to” , “means” or ”includes”. And when we see that the small useless phrase “in respect of” can be of so much importance we just tremble in awe. This extremely complex web of taxation seems to suggest that this is something very superior…that something extremely important, worthy is being planned and done…that these things are meant only for some chosen ones and this realm will remain out of the reach of normal beings like us. But for all the charisma around it, taxation system has only one purpose- to collect money and in most cases from normal ordinary human beings.

So one day, in the process of evolution, it is possible that an ape from a zoo would ask if the objective is so trivial (just collection of money, no contribution to the life and its objective) then why so much complexity in taxation system? Why to waste so much time and energy in creating such a complex system at first and then fighting for ages in courts for proving what is the “real” meaning/interpretation/coverage of a particular section of law? A beggar also collects money from other people without giving any service to them directly. Similarly taxation system also collects money from other people without giving any service to them “directly”. I am saying “direct service” because the use of the money collected from taxes for the welfare of the people may return something of value to them indirectly. But that is related to the use of money collected from taxes which if we can see suffers from even worse problems- the use of public money for productive uses is very scarce and most of the money is wasted in useless subsidies and freebies just to attract votes.

But we can see that the “usage” of money collected from taxes can be revolutionary for society and humanity- take for example that money can be used for doing revolutionary research in the field of medicine which can prolong the use full life of the human beings (not just old age where they just can breathe). But “collection” and “usage” of the tax money are altogether different and there is no doubt that “usage” definitely is more worthy and valuable. So both “collection” and “usage” need some systems to carry out the desired objectives of their creation but “collection” is a subordinate to “usage” and the efficiency of “collection” system is crucial to the ultimate objectives of “usage” system.

And the efficiency of taxation system is not in the complexity but in the simplicity. Complex system does not result in more tax revenues but more disputes and so much of the productive resources of an economy are consumed in this process of litigation. People confirm the efficiency of taxation structure on the basis of cost incurred for tax collection. The same is around 1% for most of the taxes but this is the direct cost. If we can count the indirect costs due to years of litigation, lack of clarity and doubt, money spent on court and lawyer fees, social costs and most importantly lack of investment due to fear of complex taxation. If one can count these then the same will outweigh any incremental tax revenue collected by creating a complex and arbitrary taxation system. That’s why I always say that tax system should be simple. It can’t be allowed to be so complex to create havoc to the society and economy. Its construction and composition should not burden businessmen so as to discourage investment and innovation but encouraging corruption and anarchy. Taxation system should not burden people with time wasting and costly compliances. Unnecessary and large numbers of compliances like monthly and annual tax returns etc. just increase the cost of doing business and hinder the economic growth because so much of the economic resources like manpower and money are spent on ensuring these tax compliances and disputes which adds nothing/little to the GDP. These forces act more like rentier forces or toll booths on economy collecting money…a charge on economy. Without any second thought, taxation system should be simple just like 2 plus 2 is four.

If there is anything in our society which indeed deserves complexity is the easy entry of anybody in public services, administration and politics. Any fool can enter these very important social structures without any testing. Just by passing an exam anybody can become a public servant and can play with gigantic economic and social resources. We attempt to test and measure their intelligence by taking exams/tests etc. but no tests for judging the integrity, ethical buildup, compassion and thirst for social welfare in the candidates which are more important for public services than intelligence because in the absence of these attributes intelligence will lead to corruption in almost all the cases. If you ask me, compassion is also a major part of IQ not intelligence alone. No doubt that any attempt to judge these abstract attributes of human character will make the selection process very complex but this is what and how it should be- the selection process of public servants should be very complex to discourage easy entry. Only a compassionate, honest and ethical policeman can do his job meaningfully making valuable contribution to the society and where general public can have faith and confidence not fear and disgust.

Things are very strange in our society. Governments distribute much of the resources collected through taxes to poor through many social schemes. As this distribution is targeted and involved scarce money/economic resources hence there should be extreme caution and focus to not to waste or misuse this money. So this indeed requires devising a very high tech, complex, transparent system so that money does reach the needy and corruption free. But situation is just the opposite- Huge quantity of food in the form of wheat/rice is wasted in the shabby warehouses by government meant for public distribution not to forget the widespread corruption. Highly subsidized Urea is used wastefully in excess because it is cheap- in some cases around 10-20 times the required input. So this inefficiency is everywhere wherever public money is involved instead of being highly efficient.

But on the contrary, taxpayers (Income tax) work day and night and then from their hard earned money they part away very significant portion as taxes. So government should be thankful to them but instead these taxpayers are burdened with unnecessary large number of compliances and in some cases making their life miserable. Instead of giving some exclusive benefits (like lower toll charges etc.) taxpayers are burdened with huge obligations although they give money (as tax) for free but the receiver of this (both direct and indirect taxes) money (including Government) who are receiving this for free have virtually no obligation towards proper and authentic utilization.

Similar is the case for indirect taxes. It is true that the collectors (businessmen/firms/companies etc.) of these taxes are dealing with public money so it must be ensured that they are doing this in good faith and there is no misappropriation and avoidance but still the prime responsibility for ensuring this lies with the tax department not on the assesse. So tax departments should devise systems to ensure most of the compliances indirectly rather than assessees spending big time and money on ensuring the same.

PART-2 GST

GST is one such attempt to bring simplicity to the taxation and to create an environment of flexibility, freedom, fearlessness, clarity, perspective and lower compliances. It is indeed a step in the right direction but as of now it still needs fine tuning.

Low compliances is one area where simpler rules/formats can ensure easy life for businesses. But seamless Input tax credit (ITC) is another area of equal importance and in no case a law should arbitrarily deny input tax credit to a business. In my view, for a business which is discharging output tax (GST) liability the right to avail ITC is a fundamental constitutional right. No law should attempt to disallow ITC just for the sake of revenue.

Disallowance of ITC of certain supplies in GST

GST act has disallowed the ITC of many input goods and services under section 17(5) of CGST act. One such disallowance (Clause (c &d) of section 17(5)) is against works contract services and goods/services used for the purpose of construction of immovable property other than plant and machinery even when these are used for the purpose of furtherance of business. Apart from exception in the form of plant and machinery the other exception is where works contract service is the input service for further supply of works contract service. Below is the reading of the Clause (c &d) of section 17(5):

input tax credit shall not be available in respect of the following, namely:
(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;
(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.

To explain the impact of this let’s take the example of Mahindra logistics Ltd which is a logistics player. Mahindra has built a warehouse for storing the goods of his customers and earns income from storage charges. Mahindra has incurred huge costs/investments in constructing this warehouse and must have paid GST on the procurement of all the goods and services which is Input tax for Mahindra. But as this warehouse is an Immovable property so due to the restrictions imposed by this section (immovable property and services offered not being of works contract but storage charges) Mahindra can not claim the ITC of the GST paid on its input goods and services used for the construction of warehouse. These logistics firms do not have large variable costs and their biggest cost is the cost of construction of warehouses etc. Their employee cost is lower than depreciation charge. Even if Mahindra take the warehouses on lease there will not be any difference because the firm who is leasing the warehouse to Mahindra must have forgone its ITC and thus the same has become its cost of construction which will increase the lease charges for Mahindra.

For a warehouse costing 50 cr the loss of ITC of GST will be around 9 cr which is substantial. One can easily see that this does not look very logical because Mahindra is paying the output GST on storage charges earned from its customers so it should get the ITC of input goods and services. The right to avail input credit is related to the payment of output tax and it can’t be restricted on any “particular” class of goods and services per se. same is the case with hotel industry where assets created are immovable but services offered are not works contract.

Violation of constitutional Right to Equality

There is no doubt that it is against the right to equality accorded by Article 14 of Indian constitution which is one of the six fundamental rights in the Indian constitution. Right to equality ensures that there shall not be any arbitrary discrimination between one citizen and the other. It applies to all persons like corporates which are legal persons. For more clarity, take the case of some steel pipe maker like Jindal. Jindal is buying steel and other goods and services for manufacturing steel pipes and is paying GST on all these input goods and services. Jindal is also paying output GST on its sale of steel pipes and as per GST law it can avail the ITC of GST paid on input goods and services. If we can see there is not any difference in the business model- both are paying output GST on their products but Jindal is entitled to claim the ITC of its major input goods and services while on the other hand Mahindra can’t claim the ITC of its major input goods and services. So one can clearly see that both are not treated as “equal” by the law and hence the same is unconstitutional and there are high chances that the Apex court may declare it so on one fine day. But I am leaving this constitutional part here due to length of this article but will explain the same in detail in some other post.

ITC of enabling works by Infrastructure firms

The issue I am going to discuss in this post is related to availment of ITC of enabling works by Infrastructure firms. Generally Infrastructure firms like L&T takes the orders from customers for construction of things like Power plants, Dams, road, Railway lines etc.  Take the example of an order received by L&T from NTPC for construction of a power plant of 800 MW. Here, L&T will be constructing the power plant on land belonging to NTPC. In most cases, NTPC buys the equipments related to power plants like Boiler, Turbine from other firms like BHEL and the same it hands over to L&T for erection and construction of power plant.

These construction firms need to construct sheds/stores for the storage of various materials it receives from NTPC and its own, development of open yard, fencing, electrification work of the open yard and Sheds for security and traceability, building approach roads etc. All this basic infrastructure is collectively called enabling works. The land for constructing store etc. is given by NTPC and as per contract terms L&T is required to demolish the same after the project is completed and no charges are charged by NTPC for the usage of the land.

These days infrastructure firms are using Pre-fabricated/pre-engineered materials (PEB) for the construction of enabling works (Closed and semi closed sheds) at their project sites. PEB building consists of a structural steel framing system, supporting a metal roofing system and the wall panels of varying materials. In PEB buildings, the building structure is built of steel frames instead of concrete and in most cases these steel frames are fabricated elsewhere in a factory and then brought to the site and then the same are installed using screws and welding etc. Also, the side walls and roof of the storage shed is also made of steel panels and roofing sheets. Apart from reduced construction time and lower cost, the main advantage of PEB structure is that the material is re-usable. The steel structure can be removed from site office without damaging the same and same can be reused at other project sites and after transporting the same to other sites it retains its original functionality. So this is a true green material.

Now the question here is- whether PEB building/enabling works is an immovable or movable property as the availment of ITC of GST paid on construction of the enabling works is dictated by this factor and if PEB building is immovable then no ITC will be available and cost implications are huge.  General industry view is that the same is immovable. Further doubts have been raised over this in the wake of recent ruling given by Advance ruling Authority West Bengal in case of Tewari Warehousing Co Pvt Ltd that ITC is not admissible on construction of a warehouse with prefabricated building blocks.

So in the next paragraphs I’ll try to explain the same. Whether some structure is immovable or movable is relevant not only from the perspective of ITC of GST but also in cases where a building is sold for significant amount and costly machinery is also installed/fabricated in the same building. So now the question may arise whether this transaction is one of sale of immovable property and will attract registration and stamp duty charges on registration/transfer of the building on the entire transaction value or else the transfer of machine is not sale of immovable property but one of sale of goods and thus GST is required to be paid on the same. One can see the involvement of huge sums in the form of registration & stamp duty charges and GST.

As per the Act, the ITC is restricted on the basis of Immovability not on the basis of capitalization. In fact, the ITC is allowed even for immovable property if the same is not capitalized hence we need to test whether the construction of enabling work falls under movable or immovable property.

(A) Construction of PEB enabling Structure  is movable or immovable?

First of all we need to find out what actually is immovable property. The same is defined in General clauses act 1897, Registration act 1908 and Transfer of property act 1882 which say that Immovable property includes land, benefits to arise out of land and things attached to earth. General clauses act and Registration act do not define the meaning of “attached to earth” but the same is done by Transfer of property act. It defines it as:
(a) rooted in the earth, as in the case of trees and shrubs;
(b) imbedded in the earth, as in the case of walls or buildings; or
(c) attached to what is so imbedded for the permanent beneficial enjoyment of that to which it is attached;

As per above, there is no doubt that land and a concrete building is an immovable property. But matter becomes complex when it is about movable things becoming immovable after being attached to these immovable civil structures like a machine or PEB material. To settle the same guidance is provided by the clause (c) above which provides for the permanent beneficial enjoyment of that to which it is attached.

This clause provides that a thing becomes immovable if the same is attached to an immovable structure and such attachment is for the permanent beneficial enjoyment of the immovable property (not of the thing) to which it is attached. These things are not immoveable properties per se but they become immovable as they are permanently attached/fixed to a foundation embedded in earth. So the pressing issues and tests here are 1) permanent attachment and 2) thing to be enjoyed. Major issue involved in deciding permanent attachment is the intent which further involves Object and Mode/extent/degree of annexation to the earth. Let’s have a look at these issues:

1)Thing to be enjoyed: As per this clause, if a thing is attached to an immovable structure embedded in land like wall or civil structure then that thing becomes part of immovable property if by attachment the intention is to enjoy the benefits of wall/civil structure not of the thing which is attached to that structure. So if a chattel is attached to a wall for beneficial enjoyment of wall then the chattel becomes part of immovable structure. However If the attachment is made for the beneficial enjoyment of the chattel itself, then it remains a chattel not immovable property, even though fixed for the time being so that it may be enjoyed.

This explains why door/windows are considered immovable structure because when we attach a door to a wall, then we are not enjoying the door but through door we are enjoying the benefits of room because door on its own is incapable of providing any enjoyment. The same thing is also true for windows as they are just allowing us to enjoy the beneficial enjoyment of our house. But the same thing is not true for AC because when we attach an AC to the wall then the intent is not to enjoy the benefits of wall but of AC as a separate fixture and further we can remove the same without any damage to wall and AC and the same can be reused. So AC fulfills the twin tests of destructibility and beneficial enjoyment of the chattel itself.

1(a) Applying the above test on Construction of PEB Enabling shed at project sites: When we apply same analogy to construction of PEB structure at project sites, one can see that when we attach PEB material to the civil structure or foundation then the intention is not to enjoy the civil structure/foundation (means land) but PEB material itself (of space not land). So by constructing PEB shed the intention is to enjoy the PEB shed itself hence PEB shed is a movable property. Similarly when we make civil foundations, we are getting beneficial enjoyment of land so civil foundations are immovable structure.

Further, even without constructing walls and roof from PEB material we can still enjoy the benefits associated with land as we can place all the materials on land (civil structure/floor) without walls and roof. So the purpose of walls and roof is not to enjoy the benefits associated with land but to ensure security and safety from environment damage. But if the purpose of walls and roof (if made of concrete) is not to enjoy the benefits associated with land then why they are regarded as immovable property. Actually walls/roofs are regarded as immovable property not because they get beneficial enjoyment of land but because walls and roofs are embedded into the earth (as per clause (b) above of Transfer of Property act) which fulfills the condition attached to earth and so the same is immovable property. But it has no relation with beneficial use of land.

Same view has been taken by various courts in a number of cases:

In case of SRI VELAYUTHASWAMY SPINNING MILLS (P) LTD vs THE INSPECTOR GENERAL OF REGISTRATION Madras High court settled: “In the case before us, the attachment of the oil engine to earth, though it is undoubtedly a fixture, it for the beneficial enjoyment of the engine itself and in order to use the engine, it has to be attached to the earth and the attachment lasts only as long as the engine is used. When it is not used, it can be detached and shifted to some other place. The attachment, in such a case, does not make the engine part of the land and as immovable property”.

Calcutta High Court in Janchand v.Kishore (AIR 1960 Calcutta 301) has held that the test is whether the annexation is with the object of the permanent beneficial enjoyment of the land or building. The Court held that the machinery was not attached for the mere beneficial enjoyment of either the soil or the concrete; it was actually a case of the structure being built around the machinery to protect it.

2) Tests of Permanent attachment: Technically nothing can be attached, annexed or embedded into earth permanently. So “attached forever” can’t be the test for judging the annexation to earth. Here, the intent/purpose behind the attachment confirms the annexation to earth because the things under consideration are itself movable but they are considered immovable due to attachment to the immovable structure so intent behind such annexation is the primary factor. The intent is guided by the “mode” of annexation and “object” of annexation. The mode/nature of annexation involves the test of destructibility while object of annexation further (apart from thing to be enjoyed) involves the intended duration (long term vs short term) of the annexation i.e. whether attachment is intended to be permanent.

Various Indian courts have considered these tests as most relevant while deciding the immovability. The object of annexation is determined by facts and the circumstances of each case. However, most important thing to be kept in mind is that the permanent attachment test is relevant only when the thing is not embedded into earth like wall or building because when it is so then that wall or building is an immovable property courtesy clause (b) of the definition of “attached to earth” of Transfer of Property act. If a thing is not embedded into earth like wall or building then the relevant factor is whether the intent is to attach the thing permanently into earth. That’s why for our PEB structure this test is more relevant as PEB structure is not embedded into earth like wall or building. So the intent behind attachment (permanent or temporary) of this structure into earth is to be checked.

The English law has also evolved the twin tests of degree/nature or mode of annexation and the object of annexation. In Wake v. Halt (1883) 8 App Cas 195 where, speaking for the Court of Appeal, Lord Blackburn stated: “The degree and nature of annexation is an important element for consideration; for where a chattel is so annexed that it cannot be removed without great damage to the land, it affords a strong ground for thinking that it was intended to be annexed in perpetuity to the land.

Supreme Court in CCE v. Solid & Correct Engineering Works and Ors 2010 (252) ELT 481 (SC) has opined that an attachment without necessary intent of making the same permanent cannot constitute permanent fixing, embedding or attachment in the sense that would make the machine a part and parcel of the earth permanently. Hence, the Supreme Court held that the plants in question were not immovable property.

Here, SC observes that attachment of the plant to the foundation is not comparable or synonymous to walls and buildings embedded in the earth, because a building embedded in the earth is permanent and cannot be detached without demolition.

Apart from destructibility test, another important aspect is the whether the intention is of temporary or permanent (duration) attachment of the structure. There are cases where machinery installed by monthly tenant was held to be a moveable property as in cases where the lease itself contemplated the removal of the machinery by the tenant at the end of the tenancy. The same point was also considered by SC in CCE v. Solid & Correct Engineering Works.

Also, in the above case of Tewari Warehousing Co Pvt Ltd, AAR West Bengal, while giving the ruling, has taken into consideration the fact that the Applicant has taken the land to build warehouse on 30 years lease and the same is further extendable after this period so the intention is to use the warehouse as permanent structure as they are not going to (have no plans) to remove the same in the near future.

In Subramaniam Chettiar v. Chidambaram Servai ('40) 27 A.I.R. 1940 Mad. 527 it has been pointed out that when the owner of a building installs machinery therein he may well have intended to make a permanent improvement to the premises which he owned in order to facilitate the user of those premises but that a tenant in temporary occupation of leased premises is not likely to have had any such intention in making the improvement and he accordingly held that the oil engine did not become and was not therefore immovable property.

Madras High Court in Mohammed Ibrahim v. Northern Circars Fibre Trading Co has opined that 'when the owner purchases the land and the machinery, he cannot be said to have the same intention which his vendor had.

Calcutta High Court in Jnan Chand Chugh vs Jugal Kishore Agarwal And Ors. on 21 September, 1959 has observed that “the important test is what was the intention of the owner when bringing the machinery on the land and setting the same up. The owner only had a monthly tenancy. The nature of the structure in which the machinery was housed shows that the object was somehow to keep off wind and water. The reason is obvious; the land was held on the basis of a monthly tenancy and but for the legislation now in force the tenant could be asked to quit on a few months' notice at the most. The whole building seems to me to have been put up in such a way that it could be dismantled and removed elsewhere at a short notice and without much expense. In my view, it is clear that the owner did not want to make the machinery a part of the land at all.

2(A) Applying the above 2 tests on Construction of PEB shed at project sites: In order to decide whether the construction of enabling sheds by PEB material in our project sites is resulting in immovable property we need to apply above two tests of Mode & object of annexation and permanent annexation.

(1) Testing intention for permanent annexation: As explained above, for PEB structure this test is more relevant as PEB structure is not embedded into earth like wall or building. So the intent behind attachment (permanent or temporary) of this structure into earth is to be checked. in our case from the very beginning the intention behind construction of PEB enabling work is to dismantle and transport the same to other sites at the end of the project so the intention is not for permanent attachment but only for the temporary attachment of the structure and hence the same is a movable property. The same can be assessed from the fact that in the past also for similar work done in many sites; we have transported/moved the PEB material to other sites for reusing the same.

 Further, as per the customer contract the infrastructure developer (L&T in our case) is required to dismantle all the temporary structures before leaving the project site after work completion so it is settled well before the start of construction that the time span of the structure is limited (generally for 4-5 years) and to be used temporarily. So as is evident the intention is only for short period that’s why to better manage the capital costs pre-fabricated material is preferred so that the same can be reused at other sites.

2. Test of destructibility: the PEB material can be removed from site office without damaging the same and the after transporting the same to other sites it retains its original functionality.

3. No interest or ownership of land: further the land on which enabling structure is built neither belongs to L&T nor there is any long term lease with customer. Hence it is evident from the very beginning that the PEB structure to be built is only for short duration of time and intention is never for the permanent attachment of the PEB structure into the earth.

From above discussions, it is clear that construction of shed from PEB material at project sites does not become part of immovable property after attachment to the civil structure/foundation. construction of enabling work (Closed and semi-closed Sheds) is construction of movable property hence we can take the ITC of construction work (supply as well as erection work) as the blockage under section 17(5) (c&d) comes into force only when the structure is immovable so we can take the ITC of all the material and services (supply of PEB material and cost of construction also) which are used for constructing the “movable structure”.

Apart from main PEB structure of Closed and semi-closed sheds, I have tried to test the above ratios on other components of an enabling structure:

(B) ITC of Civil Foundation, boundary work, sanitary works, flooring, Shuttering etc.: In all these items, the structure/things are permanently attached to the land/foundation (immovable structures) so it is not possible to remove the same without damaging the structure and its reusability. In fact, the material used in these works is sold as scrap and the same is never transported to other sites. Hence the ITC related to these works should not be taken. In the act, the ITC of civil foundation is allowed only in case of Plant and machinery like when we build the same for placing genset. Here the intention is not to use the benefits related to land but of machine (genset).

 (C) ITC of electrical work of open yard: The purpose behind development of open yard is the beneficial enjoyment of the land. However, the electrification work of the open yard in the form of poles/lights etc. does not enable/facilitate the beneficial use of land. In fact, the main function of electrification work at open yard is to provide security and traceability at night. Further, these poles can be removed very easily and we also shift these electrical poles to other sites for reuse. So this passes the tests enumerated above i.e. Thing to be enjoyed, permanent attachment and mode & objective of annexation. Hence keeping this in view, the ITC related to electrical work at open yard shall be taken.

(D) ITC of Fencing and Gates: Purpose of fencing is to safeguard/security of material not of beneficial enjoyment of land and it is not permanently attached/affixed or fastened to earth as these can be removed fairly easily and can be reused at other sites. So we shall take the ITC of the fencing and gates.

Hence as per above points, we shall take the ITC of PEB material supply and construction work, open yard electrical work and Fencing and gates. Except the items I have explained above I have left other items related to construction of enabling works at project sites but I do not think that apart from the above 3 cases the chances of other items passing the movable test are very less and will be disputable.
I have done a rough calculation for development of open yard and construction of 6 nos. closed sheds costing around 8 cr and as per the calculation ITC of Rs. 60 lacs can be taken against total GST impact of some 1.40 cr which is around 8% of the total cost of construciton.

But why disallowance of ITC related to Immovable property at first and possible solution

It appears that the main intention behind the blocking of ITC as per this section is to safeguard the state revenue because when a permanent structure is sold the same is treated as sale of immovable property and hence not taxable under GST as only movable goods are liable for GST. So as there is no GST on sale so any ITC allowed earlier will result in loss of revenue to the state. Although here, in case if enabling work, neither infrastructure developer (L&T) is the owner of the land nor there is any long term lease so there is no chance that L&T can sell the structure as immovable property.

But if we can see the basic premise of value added tax of ensuring seamless input tax credit then this should not be an excuse to deny the ITC of legitimate inputs used for providing taxable output service or sale of goods. Surprisingly the GST act has made sure that for real estate transactions which are also immovable ITC is allowed. Clause 5(b) of Schedule II of the CGST act provides that construction of building etc. is a service (except where the entire consideration has been received after issuance of completion certificate). So by declaring the same as service the act has paved the way for the builders to avail the ITC related to construction of building etc.

Similarly, in case of construction of immovable property the focus should not be on denial of ITC at first but on eliminating the subsequent loss of revenue in the form of ITC availed of immovable business property which later on sold without paying any GST. For ensuring the same In GST act, a special provision can be inserted which provides for the reversal of proportionate ITC availed of Immovable property which later is sold off. By this way, revenue loss will be stopped but this will ensure the same level playing field for companies using immovable properties for providing output supplies like Hotel, Logistics and retail firms.

In fact, a similar clause is already provided in the CGST act. Section 18(6) of CGST act provides that in the case of sale of capital goods or plant and machinery, on which input tax credit has been taken, the registered person shall pay an amount equal to the input tax credit taken on the said capital goods or plant and machinery proportionate to the depreciated value of said machinery or the sale price whichever is higher. Similar provision can be created for the payment of GST liability on sale of immovable property used for the purpose of providing output supply. And since enabling work is also used by infrastructure firms for the purpose of furtherance of business so full ITC should also be allowed.

Whether enabling work is  deferred revenue expenditure not capital asset?

Further, i also think that in the above case of construction of enabling work we can even claim the ITC of entire amount incurred for the development of enabling work. I am still working on this but let me share the basic premise for this. Actually as per the GST act, the ITC is disallowed if the immovable property is capitalized. Here, the main test is capitalization. But in case of enabling work, in my view these are treated as assets not because they are capitalized but because they are “deferred revenue expenditure”. Deferred revenue expenditure is where we have made the full payment but those are not consumed immediately or consumption extends beyond next 12 months. In other words, the benefit of expenditure incurred extends beyond one accounting period like for example expenditure on issuance of bonds, advertising and marketing spend on launching a new product. These deferred expenditures are held as non-current assets on the balance sheet.

So normal capitalized assets are charged off via depreciation but deferred revenue expenditure is written off in the following 3 to 5 years as per the period of benefit. I think the expenditure on enabling work is in the nature of deferred revenue expenditure and so we should get the ITC of the entire amount spent on the construction/development. I’ll share more on this after doing much detailed homework.

(Views are personal)