Things to Know before investing in Non-Convertible Debentures
1. What are Non-Convertible Debentures?
Non-Convertible Debentures are the Bonds issued by Corporate (including NBFCs) to raise funds for their projects. Non-Convertible Debentures cannot be converted into shares of the issuing company like convertible debentures.
Non-Convertible Debentures bears a fixed interest rate called Coupon Rate. The Coupon Rate is fixed at the time of issuance of the debentures.
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2. Types of Non-Convertible Debentures.
Based on Interest:
- Cumulative Payouts: Under this option Interest on NCD is paid out along with the principal amount at the time of maturity.
- Regular Payouts: Under this option Interest on NCD is paid at the regular intervals i.e. monthly, quarterly, half-yearly or yearly as specified while investing.
Based on Security:
- Secured NCDs: Secured NCDs are backed by the assets of the issuing company, which in the case of the default by the company in paying principal or interest due to its investor, will be sold to pay the dues.
- Unsecured NCDs: Unsecured NCDs does not have any assets for the backup, thus if the company fails to pay the dues, investor’s money would become bad. The only benefit of investing in unsecured NCDs is a high rate of return.
Based on Tenure:
- Call Option NCD: Under Call option NCD, issuer i.e. company who is issuing the NCD has the option to redeem the NCD before maturity.
- Put Option NCD: Under Call option NCD, the investor has the option to redeem the NCD before maturity.
3. Features of Non-Convertible Debentures
- NCDs are listed on at least one Stock Exchange (NSE/BSE).
- DEMAT is necessary to buy and sell NCDs because issuance and trading are done in Demat form only.
- If the regular payout option is chosen, interest will be paid through Direct Credit / ECS / RTGS / NEFT mode.
- Good credit rating from any of the one credit rating agency is required for the corporate (including NDFCs) to issue an NCD.
4. Benefits of investing in NCDs
- Better Returns: NCD’s provide a higher rate of interest from Bank FDs for their investors. The average rates of return in the last few years have been 11%-12%.
- Good Liquidity: Since NCDs are listed on stock exchanges, NCDs can be easily bought or sold. However, trading in NCDs is not so frequent, so one might not get the right price in case of selling in the short term.
- Higher Safety: NCDs have been rated ‘LAA+’ by ICRA, indicating high credit quality and low credit risk, and CARE AA+ by CARE, indicating high safety for timely servicing of debt obligations.
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5. Tax Implications on NCDs in India
Tax on Interest:
- TDS (Tax deductible at source) is not applicable on NCDs as per the provisions of Sec 193 of the IT Act.
- The interest will be added in the head “Income from Other Sources” and taxable as per the income tax slab of the investor.
Capital Gains Tax
- If NCDs are sold within 12 months from the date of the issue than the gains would be taxable as short term capital gains and if sold after 12 months than it would be termed as long term capital gain.
- Short-term Capital gains would be added in the income and taxed accordingly
- Long-term Capital Gains would be taxable at the flat rate of 10% (without indexation) u/s 112 of the Income Tax Act since no cost indexation is available in case of debentures and bonds.
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6. Who Should Invest in NCDs?
- Investors who are looking for a stable, consistent and regular return with low risk.
- Fixed Deposit Investors can look at NCD’s to improvise their returns.
- Investors who wish to diversify their portfolio with Fixed Income security.