Rating agency Moody's on Monday said the Rs 20,465 crore tax demand raised on Cairn India is negative for its parent company Vedanta Resources.
"The tax dispute comes at a time when Vedanta is already struggling to stave off the effects of weak oil prices. If the liability materialises, Vedanta's credit profile would be weaker than the parameters required by its current rating..." Moody's VP and senior credit officer Alan Greene said.
Last week, income tax department had slapped a Rs 20,495 crore tax demand on Cairn India Ltd for allegedly failing to pay taxes on gains made by its former parent (Cairn Energy) in a share transfer transaction about eight years ago.
"Vedanta Resources Plc's 'Ba1' corporate family rating and 'Ba3' senior unsecured ratings are under negative pressure because of a demand by Indian revenue authorities that Cairn India Ltd should pay a $3.2 billion tax liability," Moody's investors service said.
An adverse outcome for Vedanta in relation to the tax dispute could also lead to a ratings downgrade, it added.
It said Vedanta's credit metrics are already at the lower end of its rating category. The rating agency had revised the company's ratings outlook to negative in January 2015 to reflect the company's likely lower earnings due to depressed global oil prices.
Moody's said it has kept Vedanta's ratings and outlook unchanged, because it believes the tax claim will not lead to any immediate cash demand, and that the final amount could vary, given that Vedanta is challenging the liability.
Cairn India, an oil and gas producer with a 59.9% stake held by Vedanta, had received a tax notice from the Indian revenue authorities for its alleged failure to deduct withholding tax on alleged capital gains of Rs 24,500 crore made by its former parent during the fiscal year ended March 2007.
While Moody's said that Cairn India's almost 60% reduction of its planned capital expenditure to $500 million for the financial year ending March 2016 is a positive development, however, lower Brent crude oil prices will negatively affect Vedanta's profitability and cash generation.
Moody's expects Brent crude oil prices to average about $87/barrel in the year to March 2015 and around $57/barrel in the year to March 2016.
The disputed tax liability could constrain the group's liquidity. In September 2014, Cairn India's cash balances totalled around $2.7 billion, accounting for one-third of the group's liquid assets.
"As long as the tax investigation is ongoing, Vedanta will need to be judicious in its use of Cairn India's cash balances and such a situation would pressure Vedanta's broader liquidity position," Greene said.