Credit Rating Agencies
Index:
Sr. No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Topics Introduction and Efficient Date Statutory Definitions Meaning of Important Terms Types of Credit Rating Essential Ingredients Benefits of Credit Rating Process of Credit Rating Value of Taxable Service Inclusions and Exclusions Person Liable and Role of CRA’s Cenvat Credit Future Scenario and Conclusion Articles and Findings on CRAs Page No.s 04 05 05 06 07 09 10 11 11 12 14 15 17
1
Credit Rating Agencies
Credit Rating Agencies:
1. Introduction: • Service Tax on Credit Rating Agencies (CRA) services has been imposed with effect from 16-10-1998. • This was necessitated on account of the need to protect the interest of small investors. • The Credit Rating Agencies rate (or give grades) an organization which raises funds by assessing the creditworthiness of the borrowers. • Rating is done after taking various factors into consideration, like degree of security, repayment of interest, principal repayment, etc. • CRA also rate mutual funds. • The gross amount charged by such agencies from the client for rendering taxable services is chargeable to service tax under this head. • CRA helps in the development of financial markets. Credit rating agencies play a key role in the infrastructure of the modern financial system. ? Origin: • Lack of symmetric information and high costs of collecting information increased the popularity of credit rating agencies. • The world’s biggest rating agencies are moody’s investors service and standard and poor’s (S & P). • India was first among the developing nations to set up a CRA - Credit Rating Information Service of India Ltd (CRISIL) in 1988. Then came Investment Information and Credit Rating Agency of India Ltd. (ICRA) in 1990 followed by Credit Analysis and Research Ltd. (CARE) in 1993.
2
Credit Rating Agencies
2. Efficient Date: • The levy of service tax under this head is from the following dates: Services actually provided From 16-10-1998 Services to be provided From 16-06-2005 3. Statutory definitions: • Some of the important definitions are as under: ? Credit Rating Agency: Section 65(34) of the Act defines a Credit Rating Agency as follows: “‘Credit Rating Agency’ means any person engaged in the business of credit rating or any debt or obligation or of any project or programme requiring finance, whether in the form of debt or otherwise, and includes credit rating of any financial obligation, instrument or security, which has the purpose of providing a potential investor or any other person any information pertaining to the relative safety of timely payment of interest.” ? Taxable Services: Sec 65 (105)(x) of the Act defines ‘taxable services’ as any service provided or to be provided to a client by a credit rating agency in relation to credit rating of any financial obligation, instrument or security. 4. Meaning of some important and useful terms: The meaning of the following terms is also relevant for this levy: 1) Rating is an expression of opinion about the inherent strengths of the instrument or programme rated which is done by the credit rating agencies on behalf of the clients for which purpose a written agreement is entered into. • The agreement specifies the fees of the rating agency which is generally expressed as a percentage of the amount of debt sought to be raised the agreement also specifies the charges for the regular surveillance (close 3
Credit Rating Agencies
observation) of the existing rating and whether it needs to be revised or otherwise. After the rating is communicated, the rating of any instrument remains under surveillance until the entire debt is repaid. The surveillance is a mandatory exercise of credit rating agencies. Service tax is also payable on such surveillance fees. The credit rating is explained basically by intuition - the A credit denotes lowest risk, the C and D are the highest risk and totally unacceptable for investors. The credit rating meaning assigned by raters to governments and corporations can be short or long term and reflect the ability of the entity to repay its debt obligations. Governments who tend to pay obligations in their own currency score lower in credit rating than those paying foreign-currency obligations.
• • • • •
•
2) The word Client means ‘ a person who engages the professional advice or service of another therefore, the services provided by an employee of an organization who renders specific service to an organization cannot be termed as services rendered to a client as he is not a separate person. • As, to be a client it must be somebody external since no one can be a client of himself. 5. Types of Credit Rating: • Credit ratings are of different types depending upon the requirements of the rater and rated. The following are the common types of rating. 1. Bond rating: Rating the bonds or debt securities issued by a company, government or quasi-government body is called bond rating. This occupies the major business of credit rating agencies.
4
Credit Rating Agencies
2. Equity rating: The rating of equity of capital market is called equity rating. 3. Commercial paper rating: It is mandatory on the part of a corporate body to obtain the rating of an approved credit rating agency to issue commercial paper. 4. Sovereign rating: This includes rating a country as to its creditworthiness, probability to risk, etc.
6. Essential Ingredients: • Some of the essential ingredients for this levy are: I. The agency must be a person which means a commercial concern and is not limited only to a natural person but also includes artificial persons like partnership firm, HUF, corporate bodies, association or body of individuals, charitable institution, government under taking, cooperative societies, etc. II. The person must be engaged in the business of commercially providing specified services i.e. the provision of services must be a regular, organized and a continuous business activity of credit rating of instrument of various types. III. The service must be provided or to be provided by a credit rating agency in relation to credit rating to a client who is a potential investors or any other persons. IV. The service is provided or to be provided to a client which must be of credit rating of specified items or areas like rating of debts obligation, any project or programme requiring finance in any form of, any financial obligation, instrument or security like: a) Equity shares b) Preference shares 5
Credit Rating Agencies
c) Cumulative convertible preference shares d) Debentures-partly, fully or non-convertible e) Bonds long term and short term f) Fixed deposits g) Commercial paper h) Mutual funds units i) Bills receivables/Books debts etc. j) Securitized debt k) Any other security or borrowing programme l) Security or adjudging the credit worthiness of any person or organization V. The information to be provided must be a potential investor or to any other person and the information should pertain to relative safety of timely payment of interest and/or principal. VI. Information and advisory services, indexing service, business outlook of company, customized services on business houses and capital markets, macro study of infrastructure sector, implication of government policy in respect of any sector, financial modeling, bid evaluation, power purchase agreement, etc. are not services in relation to the credit rating of any financial obligation, instrument or security and are hence outside the gamut of service tax on the services of credit rating agency and hence, will not be considered as a taxable service under this category. VII. If rating is for any thing, which does not involve financial instrument or obligation or security it would not be covered under this category, for e.g. Real Estate Credit rating assigned for real estate projects, insurance companies, corporate governance etc shall not be covered as rating for the purpose of this service. VIII. Any amount received as advance for service of rating to be provided to the client is only an advance and the service can only be deemed to have been provided 6
Credit Rating Agencies
only when the rating exercise had been completed, taxable service have been rendered and when rating of any instrument has been assigned. In case the rating is not done and the mandate is cancelled for any reason and the advance has to be returned back to the client it can not be said that the services has been rendered and this sum would not be subject to service tax. IX. Similarly, in case of ongoing projects where rating has been done subsequently, the relevant date for determining service tax liability would be date when the rating has been assigned to a particular instrument. X. Presently there are four approved rating agencies functioning in India, they are : • CRISIL – Credit Rating and Information Services of India Ltd. • ICRA – Investment Information and Credit Rating Agency of India Ltd. • CARE – Credit Analysis and Research Ltd. • Fitch – Fitch Rating India Private Ltd. 7. Benefits of Credit Rating: • The benefits to various parties concerned with credit rating are listed below: Investors: 1. It enables the investors to get superior information at low cost. 2. It enables the investors to take calculated risk in the investment decisions. 3. It encourages the common man to invest his savings in corporate securities and get higher return. Corporate Borrowers: 1. It facilitates companies with good ratings to enter the capital market confidently and raise funds at comparatively cheaper rates. 7
Credit Rating Agencies
2. It can be used as a marketing tool. 3. It facilitates foreign collaborations. 4. It encourages disciplines among the corporate borrowers. Credit rating companies: 1. The existence & development of credit rating companies largely depends upon their performance. 2. Honest and impartial Credit rating agencies would definitely thrive, a long as the sustain their credibility. Government: 1. Fair and good ratings motivate the public to invest their savings & in good shares, deposits & debentures. Thu the idle savings of the public are channelized for productive uses. 2. It facilitates the formulation of public policy guidelines on institutional investment. • Credit rating system plays a vital role in investor protection without casting burden for that responsibility on the government. 8. Process of Credit Rating: • The rating exercise commences at the request of the company. • A rating applies to a particular debt obligation of the company and it’s not a general purpose evaluation of the company. • The focus of the company is on the ability and willingness of the company to meet the financial obligation on the debt instrument in a timely manner.
8
Credit Rating Agencies
? Frequency of Rating Actions: • CARE has a comprehensive in-house data base which facilitates surveillance of the various industries and companies operating in these industries. • Each rating is reviewed formally at least once a year, when analysts meet the issuer's management. • A review can also be triggered by a major development in the company or in the industry, which may have a significant bearing on the credit-worthiness of the company. As a part of the review exercise, actual financial performance is analysed in the light of the estimates made earlier and deviations are examined. • CARE puts the rating under Credit Watch, when any event or deviation from the expected trend has occurred or is expected and additional information is necessary to take rating action. • The rating may be retained, upgraded or downgraded based on the changed prospects for the issuer. • A rating change is at the absolute discretion of CARE, without concurrence of the client. 9. Value of Taxable Service: • The value of taxable service would be the gross amount charged by a credit rating agency from the client for the services rendered in connection with the credit 9
Credit Rating Agencies
rating of any financial obligation or security or instrument. • The value of taxable service shall be computed in accordance with the Service Tax (Determination of Valuation) Rules, 2006 as given in Chapter 18-H – Valuation of Taxable Services for Charging Service Tax. 10. Inclusions and Exclusions: ? Inclusions: Rating done by Credit rating agencies like (ICRA, CRISIL, CARE, FITCH), private rating agencies includes: • Rating of debt obligations that is Long-term instruments such as Debentures/Bonds and Preference shares, structured obligations (including asset-backed securities), Short-term instruments such as commercial paper programmes, etc; • Financial Instruments like bills of exchange, promissory note, etc., • Securities projects or programme or any other type of rating, etc. • IPO rating - The full form of IPO is initial public offering. It is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial public offering (IPO) of equity shares or any other security which may be converted into or exchanged with equity shares at a later date. ? Exclusions – • As per the rule 2(e), “exempted services” means taxable services which are exempted from the whole of service tax leviable there on, it means services on which no service tax is leviable under section 60 of the finance act 1994 • Rating done byo non credit rating agencies, o market researches rating agencies, o rating of non financial matters information and advisory services, o indexing services, 10
Credit Rating Agencies
o bid evaluation services, o opinion polls, o corporate government rating agency, etc are excluded. 11. Person liable: • Every credit rating agency being any person which arises a bill for taxable services rendered to a client shall be liable to pay service tax and shall be treated as an assessee for service tax purpose. ? Role of some Credit Rating Agencies in India: 1. CRISIL: • The credit rating information services of India limited (CRISIL) is the first rating agency in India which was promoted in 1987 by the Industrial credit and Investment Corporation of India Ltd. (ICICI) and Unit Trust of India (UTI). • CRISIL’s principal objective is to rate debt obligations of Indian companies. • Its ratings provide a guide to the investors as to the degree of certainty of timely payment of interest and principal on particular debt instrument CRISIL rates debentures, fixed deposit programmes, short-term instrument like commercial paper, structured obligations and preference shares. • Since inception till March 31, 1994, CRISIL has created in all debt instrument issued by 668 companies. 2. ICRA: 1. Investment Information and Credit Rating Agency of India (ICRA) does credit rating which provides an investor with a simple indicator expressing the underlying credit quality in a debt issue programme. 2. ICRA credit rating also establishes a link between risk and return. 3. An investor was the rating to access the risk-level and compares the offered rate of return with his expected rate of return to optimize the risk-return trade off.
11
Credit Rating Agencies
4. In addition, ICRA provides ‘General Assessment’ report on different aspects of the company’s operations, management. 3. CARE: • The IDBI jointly with Canara bank, UTI, private sector bank and financial services companies promoted the Credit Analysis and Research Limited (CARE) institution to offer credit rating information and quality research services to Indian industry and institutions. • CARE, incorporated on April 21, 1993, commenced its operations in October 1993. • CARE undertakes rating of all type of debt instrument like commercial paper, fixed deposit, bonds, debentures, and structural obligation, involving an independent and professional assessment debt servicing capacities of companies. 12. CENVAT Credit: • Service tax payable by an assessee is subject to assessee availing of CENVAT credit. • The expression ‘CENVAT’ stands for Central Value Added Tax and was developed to avoid cascading effect of taxes. • The term ‘Cenvat’ is used to refer to provisions in respect of credit of excise duty paid on inputs and capital goods and service tax paid on input services, which is available for payment of excise duty on final products and service tax on output services. • Output service provider shall be allowed to take credit of the tax paid on the inputs and input services only after he makes the payment for the value of input service or Inputs/capital goods or the service tax/Excise duties payable thereon as indicated in the bill/invoice of Input service provider. • Generally, any tax is related to selling price of a product. In modern production technology, raw material
12
Credit Rating Agencies
passes through various stages and processes till it reaches the ultimate stage. • Output of final goods and services involves first manufacturer who becomes the input for the second manufacturer, who carries out further processing and supplies it to third manufacturer. This product then goes to distributor/wholesaler, who passes it to retailer and then it reaches the ultimate consumer • If the tax is based on selling price of a product, the burden goes on increasing as raw material and final product passes from one stage to other. • For example, let us assume that tax on a product is 10% of selling price. Manufacturer ‘A’ supplies his output to ‘B’ at Rs 100. Thus, ‘B’ gets the material at Rs 110, inclusive of tax @10%. He carries out further processing and sells his output to ‘C’ at Rs 150. While calculating his cost, ‘B’ has considered his purchase cost of materials at Rs 110 and added Rs 40 as his conversion charges. While selling product to C, B will charge tax again @ 10%. Thus C will get the item at Rs 165 (150+10% tax). As stages of production and/or sales continue, each subsequent purchaser has to pay tax again and again on the material which has already suffered tax. This is called cascading effect. 13. Future Scenario and Conclusion: ? Future Scenario: • As our economy opens, if and is exposed to competitive climate of international finance and as investment decisions will involve more and more complex considerations, the rating system will gain strong foothold. • The ratings have gained good acceptability with various investors and this trend will consolidate itself. • With the emergence of debt markets and imminent introduction of security instruments for mortgage debts, the work of rating agencies is bound to multiply.
13
Credit Rating Agencies
• Additional skill will need to be developed for an access to overseas debt markets. • Moody’s has set up an establishment in India and standard and poor is expected to do so in the near future. • Other areas of new developments include equity research and credit analysis ratings of various companies. • The rating agencies the rating agencies will provide opinions about prospects of a company; estimates about EPS and P/E ratio, future projections, etc, with the available expertise data banks, the rating agencies are eminently suited to undertake such an exercise. ? Conclusion: • The primary benefit of credit rating has been to enable the investor to identify the risks associated with various debt obligations. • With the eruption of new financial instruments and the realization on the part of the investors of the immovable service that credit rating agencies provide, credit rating is bound to find its niche (a specialized but profitable corner of the market) in the investment decision-making process and act as positive step in the direction of increasing investor protection. • Rating agencies play an important role in world markets, they can best serve market when they operate indefinitely, adopt and enforce internal guidelines to avoid conflicts of interest and protect confidential information received from issues. • Credit rating agencies can not afford to commit too many mistakes as it is the investor who pays the price for their mistakes. • Competition in the rating agency should be enhanced by credit niche rating agencies specializing in information technology on state governments.
14
Credit Rating Agencies
Article published in a Newspaper in relation to
15
Credit Rating Agencies credit rating of a Company:
Vodafone's Indian bid may hit credit rating: reports
January 11, 2007 15:16 IST
British telecom giant Vodafone could face a downgrade in its credit rating by Standard and Poor's if its proposed bid for Hutchison Essar Ltd exceeds $19 billion, a media report said in London. Vodafone CEO Arun Sarin could trigger a credit downgrade for his company if his planned bid values the Indian mobile operator significantly over $19 billion, The Daily Telegraph said. The report quoted credit rating giant Standard & Poor's as saying that a 'meaningful step-up' in Sarin's planned offer could cause it to cut its debt rating on Vodafone from 'A-' to 'BBB+' due to increase in cost of new borrowings. It would be S&P's second downgrade in less than a year on Vodafone, reflecting rising debt levels and increased risk from the emerging markets it is moving into, the report said. "If Vodafone saw an offer too good not to take in India there is a risk that they could push the envelope a bit further," S&P analyst Simon Redmond was quoted as saying. Vodafone already owns about 10 per cent stake in India's top mobile player Bharti and is seeking to sell this minority stake and buy a controlling stake in Hutch Essar. S&P expected Vodafone to get around $2.3 billion for the Bharti stake, but a $19.3 billion bid for Hutchison Essar would increase net debt to around $48.3 billion, the report said. It also quoted brokerage firm Exane BNP Paribas as saying it 'failed to understand' how a bid valuing HEL at $17 to $18 billion could create value for Vodafone.
• Precisely, this article states as per the credit rating report made
by Standard & Poor's (Credit Rating Agency), Vodafone’s Credit rating can face a downgrade from ‘A-’ to ‘BBB+’ due to increase in cost of new borrowings reflecting rising debt levels and which clarifies that it is moving into increased risk from the emerging markets.
16
Credit Rating Agencies Bibliography:
Reference books: • Indirect taxes (law & practice) -V.S.Datey. • Students guide to Indirect Taxes -Yogendra Bangar -Vandana Bangar. • The Indian Financial System -Vasant Desai. • The Indian Financial System -Bharti Pathak. • Elements of Direct & Indirect Taxes -V.H.Krishnadwalla -N.H.Krishnadwalla -H.V.Krishnadwalla -H.M.Thakkar Websites: • www.google.com • www.rediff.com • www.crisil.com • www.wikipedia.org • www.icra.in • www.careratings.com
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doc_230423438.doc
Index:
Sr. No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Topics Introduction and Efficient Date Statutory Definitions Meaning of Important Terms Types of Credit Rating Essential Ingredients Benefits of Credit Rating Process of Credit Rating Value of Taxable Service Inclusions and Exclusions Person Liable and Role of CRA’s Cenvat Credit Future Scenario and Conclusion Articles and Findings on CRAs Page No.s 04 05 05 06 07 09 10 11 11 12 14 15 17
1
Credit Rating Agencies
Credit Rating Agencies:
1. Introduction: • Service Tax on Credit Rating Agencies (CRA) services has been imposed with effect from 16-10-1998. • This was necessitated on account of the need to protect the interest of small investors. • The Credit Rating Agencies rate (or give grades) an organization which raises funds by assessing the creditworthiness of the borrowers. • Rating is done after taking various factors into consideration, like degree of security, repayment of interest, principal repayment, etc. • CRA also rate mutual funds. • The gross amount charged by such agencies from the client for rendering taxable services is chargeable to service tax under this head. • CRA helps in the development of financial markets. Credit rating agencies play a key role in the infrastructure of the modern financial system. ? Origin: • Lack of symmetric information and high costs of collecting information increased the popularity of credit rating agencies. • The world’s biggest rating agencies are moody’s investors service and standard and poor’s (S & P). • India was first among the developing nations to set up a CRA - Credit Rating Information Service of India Ltd (CRISIL) in 1988. Then came Investment Information and Credit Rating Agency of India Ltd. (ICRA) in 1990 followed by Credit Analysis and Research Ltd. (CARE) in 1993.
2
Credit Rating Agencies
2. Efficient Date: • The levy of service tax under this head is from the following dates: Services actually provided From 16-10-1998 Services to be provided From 16-06-2005 3. Statutory definitions: • Some of the important definitions are as under: ? Credit Rating Agency: Section 65(34) of the Act defines a Credit Rating Agency as follows: “‘Credit Rating Agency’ means any person engaged in the business of credit rating or any debt or obligation or of any project or programme requiring finance, whether in the form of debt or otherwise, and includes credit rating of any financial obligation, instrument or security, which has the purpose of providing a potential investor or any other person any information pertaining to the relative safety of timely payment of interest.” ? Taxable Services: Sec 65 (105)(x) of the Act defines ‘taxable services’ as any service provided or to be provided to a client by a credit rating agency in relation to credit rating of any financial obligation, instrument or security. 4. Meaning of some important and useful terms: The meaning of the following terms is also relevant for this levy: 1) Rating is an expression of opinion about the inherent strengths of the instrument or programme rated which is done by the credit rating agencies on behalf of the clients for which purpose a written agreement is entered into. • The agreement specifies the fees of the rating agency which is generally expressed as a percentage of the amount of debt sought to be raised the agreement also specifies the charges for the regular surveillance (close 3
Credit Rating Agencies
observation) of the existing rating and whether it needs to be revised or otherwise. After the rating is communicated, the rating of any instrument remains under surveillance until the entire debt is repaid. The surveillance is a mandatory exercise of credit rating agencies. Service tax is also payable on such surveillance fees. The credit rating is explained basically by intuition - the A credit denotes lowest risk, the C and D are the highest risk and totally unacceptable for investors. The credit rating meaning assigned by raters to governments and corporations can be short or long term and reflect the ability of the entity to repay its debt obligations. Governments who tend to pay obligations in their own currency score lower in credit rating than those paying foreign-currency obligations.
• • • • •
•
2) The word Client means ‘ a person who engages the professional advice or service of another therefore, the services provided by an employee of an organization who renders specific service to an organization cannot be termed as services rendered to a client as he is not a separate person. • As, to be a client it must be somebody external since no one can be a client of himself. 5. Types of Credit Rating: • Credit ratings are of different types depending upon the requirements of the rater and rated. The following are the common types of rating. 1. Bond rating: Rating the bonds or debt securities issued by a company, government or quasi-government body is called bond rating. This occupies the major business of credit rating agencies.
4
Credit Rating Agencies
2. Equity rating: The rating of equity of capital market is called equity rating. 3. Commercial paper rating: It is mandatory on the part of a corporate body to obtain the rating of an approved credit rating agency to issue commercial paper. 4. Sovereign rating: This includes rating a country as to its creditworthiness, probability to risk, etc.
6. Essential Ingredients: • Some of the essential ingredients for this levy are: I. The agency must be a person which means a commercial concern and is not limited only to a natural person but also includes artificial persons like partnership firm, HUF, corporate bodies, association or body of individuals, charitable institution, government under taking, cooperative societies, etc. II. The person must be engaged in the business of commercially providing specified services i.e. the provision of services must be a regular, organized and a continuous business activity of credit rating of instrument of various types. III. The service must be provided or to be provided by a credit rating agency in relation to credit rating to a client who is a potential investors or any other persons. IV. The service is provided or to be provided to a client which must be of credit rating of specified items or areas like rating of debts obligation, any project or programme requiring finance in any form of, any financial obligation, instrument or security like: a) Equity shares b) Preference shares 5
Credit Rating Agencies
c) Cumulative convertible preference shares d) Debentures-partly, fully or non-convertible e) Bonds long term and short term f) Fixed deposits g) Commercial paper h) Mutual funds units i) Bills receivables/Books debts etc. j) Securitized debt k) Any other security or borrowing programme l) Security or adjudging the credit worthiness of any person or organization V. The information to be provided must be a potential investor or to any other person and the information should pertain to relative safety of timely payment of interest and/or principal. VI. Information and advisory services, indexing service, business outlook of company, customized services on business houses and capital markets, macro study of infrastructure sector, implication of government policy in respect of any sector, financial modeling, bid evaluation, power purchase agreement, etc. are not services in relation to the credit rating of any financial obligation, instrument or security and are hence outside the gamut of service tax on the services of credit rating agency and hence, will not be considered as a taxable service under this category. VII. If rating is for any thing, which does not involve financial instrument or obligation or security it would not be covered under this category, for e.g. Real Estate Credit rating assigned for real estate projects, insurance companies, corporate governance etc shall not be covered as rating for the purpose of this service. VIII. Any amount received as advance for service of rating to be provided to the client is only an advance and the service can only be deemed to have been provided 6
Credit Rating Agencies
only when the rating exercise had been completed, taxable service have been rendered and when rating of any instrument has been assigned. In case the rating is not done and the mandate is cancelled for any reason and the advance has to be returned back to the client it can not be said that the services has been rendered and this sum would not be subject to service tax. IX. Similarly, in case of ongoing projects where rating has been done subsequently, the relevant date for determining service tax liability would be date when the rating has been assigned to a particular instrument. X. Presently there are four approved rating agencies functioning in India, they are : • CRISIL – Credit Rating and Information Services of India Ltd. • ICRA – Investment Information and Credit Rating Agency of India Ltd. • CARE – Credit Analysis and Research Ltd. • Fitch – Fitch Rating India Private Ltd. 7. Benefits of Credit Rating: • The benefits to various parties concerned with credit rating are listed below: Investors: 1. It enables the investors to get superior information at low cost. 2. It enables the investors to take calculated risk in the investment decisions. 3. It encourages the common man to invest his savings in corporate securities and get higher return. Corporate Borrowers: 1. It facilitates companies with good ratings to enter the capital market confidently and raise funds at comparatively cheaper rates. 7
Credit Rating Agencies
2. It can be used as a marketing tool. 3. It facilitates foreign collaborations. 4. It encourages disciplines among the corporate borrowers. Credit rating companies: 1. The existence & development of credit rating companies largely depends upon their performance. 2. Honest and impartial Credit rating agencies would definitely thrive, a long as the sustain their credibility. Government: 1. Fair and good ratings motivate the public to invest their savings & in good shares, deposits & debentures. Thu the idle savings of the public are channelized for productive uses. 2. It facilitates the formulation of public policy guidelines on institutional investment. • Credit rating system plays a vital role in investor protection without casting burden for that responsibility on the government. 8. Process of Credit Rating: • The rating exercise commences at the request of the company. • A rating applies to a particular debt obligation of the company and it’s not a general purpose evaluation of the company. • The focus of the company is on the ability and willingness of the company to meet the financial obligation on the debt instrument in a timely manner.
8
Credit Rating Agencies
? Frequency of Rating Actions: • CARE has a comprehensive in-house data base which facilitates surveillance of the various industries and companies operating in these industries. • Each rating is reviewed formally at least once a year, when analysts meet the issuer's management. • A review can also be triggered by a major development in the company or in the industry, which may have a significant bearing on the credit-worthiness of the company. As a part of the review exercise, actual financial performance is analysed in the light of the estimates made earlier and deviations are examined. • CARE puts the rating under Credit Watch, when any event or deviation from the expected trend has occurred or is expected and additional information is necessary to take rating action. • The rating may be retained, upgraded or downgraded based on the changed prospects for the issuer. • A rating change is at the absolute discretion of CARE, without concurrence of the client. 9. Value of Taxable Service: • The value of taxable service would be the gross amount charged by a credit rating agency from the client for the services rendered in connection with the credit 9
Credit Rating Agencies
rating of any financial obligation or security or instrument. • The value of taxable service shall be computed in accordance with the Service Tax (Determination of Valuation) Rules, 2006 as given in Chapter 18-H – Valuation of Taxable Services for Charging Service Tax. 10. Inclusions and Exclusions: ? Inclusions: Rating done by Credit rating agencies like (ICRA, CRISIL, CARE, FITCH), private rating agencies includes: • Rating of debt obligations that is Long-term instruments such as Debentures/Bonds and Preference shares, structured obligations (including asset-backed securities), Short-term instruments such as commercial paper programmes, etc; • Financial Instruments like bills of exchange, promissory note, etc., • Securities projects or programme or any other type of rating, etc. • IPO rating - The full form of IPO is initial public offering. It is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial public offering (IPO) of equity shares or any other security which may be converted into or exchanged with equity shares at a later date. ? Exclusions – • As per the rule 2(e), “exempted services” means taxable services which are exempted from the whole of service tax leviable there on, it means services on which no service tax is leviable under section 60 of the finance act 1994 • Rating done byo non credit rating agencies, o market researches rating agencies, o rating of non financial matters information and advisory services, o indexing services, 10
Credit Rating Agencies
o bid evaluation services, o opinion polls, o corporate government rating agency, etc are excluded. 11. Person liable: • Every credit rating agency being any person which arises a bill for taxable services rendered to a client shall be liable to pay service tax and shall be treated as an assessee for service tax purpose. ? Role of some Credit Rating Agencies in India: 1. CRISIL: • The credit rating information services of India limited (CRISIL) is the first rating agency in India which was promoted in 1987 by the Industrial credit and Investment Corporation of India Ltd. (ICICI) and Unit Trust of India (UTI). • CRISIL’s principal objective is to rate debt obligations of Indian companies. • Its ratings provide a guide to the investors as to the degree of certainty of timely payment of interest and principal on particular debt instrument CRISIL rates debentures, fixed deposit programmes, short-term instrument like commercial paper, structured obligations and preference shares. • Since inception till March 31, 1994, CRISIL has created in all debt instrument issued by 668 companies. 2. ICRA: 1. Investment Information and Credit Rating Agency of India (ICRA) does credit rating which provides an investor with a simple indicator expressing the underlying credit quality in a debt issue programme. 2. ICRA credit rating also establishes a link between risk and return. 3. An investor was the rating to access the risk-level and compares the offered rate of return with his expected rate of return to optimize the risk-return trade off.
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Credit Rating Agencies
4. In addition, ICRA provides ‘General Assessment’ report on different aspects of the company’s operations, management. 3. CARE: • The IDBI jointly with Canara bank, UTI, private sector bank and financial services companies promoted the Credit Analysis and Research Limited (CARE) institution to offer credit rating information and quality research services to Indian industry and institutions. • CARE, incorporated on April 21, 1993, commenced its operations in October 1993. • CARE undertakes rating of all type of debt instrument like commercial paper, fixed deposit, bonds, debentures, and structural obligation, involving an independent and professional assessment debt servicing capacities of companies. 12. CENVAT Credit: • Service tax payable by an assessee is subject to assessee availing of CENVAT credit. • The expression ‘CENVAT’ stands for Central Value Added Tax and was developed to avoid cascading effect of taxes. • The term ‘Cenvat’ is used to refer to provisions in respect of credit of excise duty paid on inputs and capital goods and service tax paid on input services, which is available for payment of excise duty on final products and service tax on output services. • Output service provider shall be allowed to take credit of the tax paid on the inputs and input services only after he makes the payment for the value of input service or Inputs/capital goods or the service tax/Excise duties payable thereon as indicated in the bill/invoice of Input service provider. • Generally, any tax is related to selling price of a product. In modern production technology, raw material
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Credit Rating Agencies
passes through various stages and processes till it reaches the ultimate stage. • Output of final goods and services involves first manufacturer who becomes the input for the second manufacturer, who carries out further processing and supplies it to third manufacturer. This product then goes to distributor/wholesaler, who passes it to retailer and then it reaches the ultimate consumer • If the tax is based on selling price of a product, the burden goes on increasing as raw material and final product passes from one stage to other. • For example, let us assume that tax on a product is 10% of selling price. Manufacturer ‘A’ supplies his output to ‘B’ at Rs 100. Thus, ‘B’ gets the material at Rs 110, inclusive of tax @10%. He carries out further processing and sells his output to ‘C’ at Rs 150. While calculating his cost, ‘B’ has considered his purchase cost of materials at Rs 110 and added Rs 40 as his conversion charges. While selling product to C, B will charge tax again @ 10%. Thus C will get the item at Rs 165 (150+10% tax). As stages of production and/or sales continue, each subsequent purchaser has to pay tax again and again on the material which has already suffered tax. This is called cascading effect. 13. Future Scenario and Conclusion: ? Future Scenario: • As our economy opens, if and is exposed to competitive climate of international finance and as investment decisions will involve more and more complex considerations, the rating system will gain strong foothold. • The ratings have gained good acceptability with various investors and this trend will consolidate itself. • With the emergence of debt markets and imminent introduction of security instruments for mortgage debts, the work of rating agencies is bound to multiply.
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Credit Rating Agencies
• Additional skill will need to be developed for an access to overseas debt markets. • Moody’s has set up an establishment in India and standard and poor is expected to do so in the near future. • Other areas of new developments include equity research and credit analysis ratings of various companies. • The rating agencies the rating agencies will provide opinions about prospects of a company; estimates about EPS and P/E ratio, future projections, etc, with the available expertise data banks, the rating agencies are eminently suited to undertake such an exercise. ? Conclusion: • The primary benefit of credit rating has been to enable the investor to identify the risks associated with various debt obligations. • With the eruption of new financial instruments and the realization on the part of the investors of the immovable service that credit rating agencies provide, credit rating is bound to find its niche (a specialized but profitable corner of the market) in the investment decision-making process and act as positive step in the direction of increasing investor protection. • Rating agencies play an important role in world markets, they can best serve market when they operate indefinitely, adopt and enforce internal guidelines to avoid conflicts of interest and protect confidential information received from issues. • Credit rating agencies can not afford to commit too many mistakes as it is the investor who pays the price for their mistakes. • Competition in the rating agency should be enhanced by credit niche rating agencies specializing in information technology on state governments.
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Credit Rating Agencies
Article published in a Newspaper in relation to
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Credit Rating Agencies credit rating of a Company:
Vodafone's Indian bid may hit credit rating: reports
January 11, 2007 15:16 IST
British telecom giant Vodafone could face a downgrade in its credit rating by Standard and Poor's if its proposed bid for Hutchison Essar Ltd exceeds $19 billion, a media report said in London. Vodafone CEO Arun Sarin could trigger a credit downgrade for his company if his planned bid values the Indian mobile operator significantly over $19 billion, The Daily Telegraph said. The report quoted credit rating giant Standard & Poor's as saying that a 'meaningful step-up' in Sarin's planned offer could cause it to cut its debt rating on Vodafone from 'A-' to 'BBB+' due to increase in cost of new borrowings. It would be S&P's second downgrade in less than a year on Vodafone, reflecting rising debt levels and increased risk from the emerging markets it is moving into, the report said. "If Vodafone saw an offer too good not to take in India there is a risk that they could push the envelope a bit further," S&P analyst Simon Redmond was quoted as saying. Vodafone already owns about 10 per cent stake in India's top mobile player Bharti and is seeking to sell this minority stake and buy a controlling stake in Hutch Essar. S&P expected Vodafone to get around $2.3 billion for the Bharti stake, but a $19.3 billion bid for Hutchison Essar would increase net debt to around $48.3 billion, the report said. It also quoted brokerage firm Exane BNP Paribas as saying it 'failed to understand' how a bid valuing HEL at $17 to $18 billion could create value for Vodafone.
• Precisely, this article states as per the credit rating report made
by Standard & Poor's (Credit Rating Agency), Vodafone’s Credit rating can face a downgrade from ‘A-’ to ‘BBB+’ due to increase in cost of new borrowings reflecting rising debt levels and which clarifies that it is moving into increased risk from the emerging markets.
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Credit Rating Agencies Bibliography:
Reference books: • Indirect taxes (law & practice) -V.S.Datey. • Students guide to Indirect Taxes -Yogendra Bangar -Vandana Bangar. • The Indian Financial System -Vasant Desai. • The Indian Financial System -Bharti Pathak. • Elements of Direct & Indirect Taxes -V.H.Krishnadwalla -N.H.Krishnadwalla -H.V.Krishnadwalla -H.M.Thakkar Websites: • www.google.com • www.rediff.com • www.crisil.com • www.wikipedia.org • www.icra.in • www.careratings.com
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