CREDIT RATING SERVICES

[Mr. M. GOVINDARAJAN]

                        Credit Rating, in general sense, is the evaluation of the credit worthiness of an individual or of a business concern or of an instrument of a business based on relevant factors indicating ability and willingness to pay obligations as well as net worth. SEBI (Credit Rating Agencies) Regulations, 1999 defines 'rating' as an opinion regarding securities expressed in the form of standard symbols or in any other standardized manner, assigned by credit rating agency and used by the issuer of such securities to comply with a requirement specified by these Regulations. Credit Rating Agency is a body corporate engaged in or proposes to be engaged in the business of rating of securities offered by way of public rights of rights issue.  Credit ratings establish a link between risk and return.  An investor or any other interested person uses the rating to assess the risk level and compares the offered rate of return with his expected rate of return.

                        Credit rating is helpful in the following ways:

·        Investor can assess the risk and return;

·        Direct mobilization of savings from individuals;

·        A marketing tool to the company and investment bankers in placing company's debt obligations with a investor base;

·        Encourages discipline amongst corporate borrowers to improve their financial structure.

The following are the factors for success of a rating system:

·        Credible and independent structure and procedures;

·        Objectivity and impartiality of opinions;

·        Analytical research, integrity and consistency;

·        Professionalism and industry related expertise;

·        Confidentiality;

·        Timeliness of rating review and announcement of changes;

·        Ability to reach wide range of investors by means of press reports, print or electronic media and investor oriented research services.

The following factors are generally considered for rating in respect of companies:

§         Industry risk;

§         Company's industry and market position;

§         Operating efficiencies;

§         Accounting quality;

§         Financial flexibility;

§         Earnings protection;

§         Financial leverage;

§         Cash flow adequacy.

The following are engaged in credit rating:

§         CRISIL (Credit Rating Information Services of India Ltd);

§         ICRA (Investment Information and Credit Rating Agency of India Ltd);

§         CARE (Credit Analysis and Research Ltd);

Rating symbols are used in terms of alphabets.  For example we may take the rating symbols of CRISIL for debenture:

§         AAA - Highest Safety - on timely payment of interest and principal;

§         AA - High Safety - regarding timely payment of interest and principal;

§         A - Adequate Safety - regarding timely payment of interest and principal subject to adverse impact arising out of changed circumstances;

§         BBB - Moderate Safety - regarding timely payment of interest and principal subject to variations caused by changing circumstances weakening the capacity;

§         BB - Inadequate safety - regarding payment of timely interest and principal due to the comparative uncertainties faced by the issuer;

§         B - High Risk - susceptible to default in payment of principal and interest due to adverse business or economic conditions affecting the issuer;

§         C - Substantial Risk - Due to the presence of factors which make the issue vulnerable to default if unfavourable circumstances develop;

§         D - Default - default likely in payment of interest and maturity amount.

Thus the Credit rating services is rendered by the Credit Rating Agencies to the companies issuing any financial instrument or security. The credit rating agencies are also small in number.  This service is not required to be dealt with by service receiver.  However as an academic interest this service is dealt with in this article.

                        The Finance Act, 1998 brought the services of credit rating agencies under the net of service tax with effect from 10.10.1998. Sec. 65(34) of the Finance Act, 1994 defines Credit Rating Agency as any person engaged in business of Credit rating of any debt 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 or principal.

                        Sec. 65(105)(x) of the Finance Act, 1994 defines taxable service in relation to credit rating agency service as any service provided or to be provided to any person by a credit rating agency in relation to credit rating of any financial obligation, instrument or security.

                        The Credit Rating Agency, providing services in relation to credit rating is liable to pay service tax on taxable value of services.  Investors referring the grades of Credit Rating Agency are not required to pay service tax to credit rating agency. 

                        CBEC Instruction Letter File No. B11/1/98-TRU, dated 07.10.1998 explains the various aspects of this service.  The Credit Rating Agencies provide, among others, ratings in respect of corporate bonds, commercial paper, fixed deposits, municipal debt, infrastructure bond, utilities, asset backed securities, structured obligation, toll road bonds, mutual funds etc., All public issues of debt are statutorily required to be rated.

                        The client wanting to get rated a debt issue being floated by it requires the services of a credit rating agency.  The Credit rating agency and the issuer enter into an agreement in this regard. The agreement provides for charges for such rating services and also specifies the charges for regular surveillance of the existing rating, whether it needs to be revised or otherwise. The fees of the rating agency is generally expressed as a percentage of the amount of debt sought to be raised.  The fees on any assignment are usually paid at the time of entering into an agreement i.e., in advance.  Such amounts are kept as advance against rating fee and are recognized as income only when the rating is assigned. After the rating is given it is communicated to the client. The rating of any instrument remains under surveillance until the entire debt is repaid. The surveillance is a mandatory exercise for rating agencies. After surveillance the client is billed as per the agreed fee structure.   Service tax is payable on both on the fees on received for credit rating of the debt instrument and the surveillance fees.

                        In this letter it is clarified that information and advisory services, if any, rendered by credit rating agencies would not attract service tax for the reason that 'taxable service' in respect of a credit rating agency means services provided in relation to credit rating of financial obligation, instrument or security. 

                        The following are not services in relation to the credit rating of any financial obligation etc.,:

§         Services of research and information such as analysis of industries in specific sectors, of financial and business outlook of a company, other customized services on such business houses and capital markets, indexing services; and

§         Information services such as privatization policy for infrastructure projects, macro studies of infrastructure sector, implication of Government policy in respect of any sector, financial modeling, bid evaluation, power purchase agreement etc.,

In case rating is not done, for any reason and the entire amount is returned back to the client, it cannot be said that services have been rendered and hence service tax is not attracted. Similarly in the case of ongoing projects, where rating has been done subsequently, the relevant date for determining the service tax liability would be the date when rating has been assigned to a particular instrument.