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Everything about Non Convertible Debenture (NCD)
Companies have multiple options to raise funds, primary amongst which are the issue of shares and debentures. Whilst the former dilutes the overall ownership of the company, the latter creates debt for the company. Companies often opt for the second option i.e., issuing of debentures when they do not want to part or dilute their equity shareholding. There are two types of debentures a company can issue-
- Convertible Debentures
- Non Convertible Debentures.
What are Non Convertible Debentures (NCDs)?
Non Convertible Debentures (NCDs) cannot be converted into shares. As is the case with all debentures, NCDs fall into the category of debt instruments and generate a fixed income for the debenture holder. Each Non Convertible Debenture has a predetermined rate of interest and a fixed maturity date. The interest on NCDs can either be paid with the principal amount on the maturity date or at specific intervals, which may be monthly, quarterly, or yearly.
NCDs are further divided into secured NCDs and unsecured NCDs. Secured NCDs are backed by a collateral, which makes them safer than unsecured NCDs. In case of non-payment of principal or interest on maturity, unitholders have the option to sell the collateral and recover their principal amount or interest payments. Since the income and principal is more or less guaranteed, secured NCDs carry a lower rate of interest as the risk is lower compared to unsecured NCDs.
In order to apply for a particular company's Non Convertible Debentures, you have to wait for said company to launch a public issue of NCDs. Once such an issue is operational, you can apply for the required number of NCDs. You can also buy already issued NCDs from the open market at prevailing market price.
Features of Non Convertible Debentures
|Features of NCDs
|Non Convertible Debentures have a fixed rate of interest which usually ranges between 7% to 9%, provided you hold the instruments till their maturity date. Non-secured NCDs generally have a higher rate of interest than secured NCDs.
|Taxation upon Sale
Although there are no tax implications associated with the purchase of a Non Convertible Debenture, the sale thereof attracts a tax.
|Credit Rating of the issuing company
|The security of a Non Convertible Debenture is directly proportional to the credit rating of the company issuing the instrument. The higher the credit rating, the more secured the NCD is.
|Capital Adequacy Ratio
|A company's Capital Adequacy Ratio is an indicator of its long term solvency and ability to service its debt. Therefore, the higher this ratio, the more secured the NCDs.
What are the benefits of investing in Non Convertible Debentures?
Fixed income:One of the primary benefits of investing in Non Convertible Debentures is that they offer you a fixed income. This income is usually higher than bank deposit rates. You can choose to receive the interest payouts from NCDs in one lump-sum along with the principal amount at maturity or opt for regular interest income on a monthly, quarterly, or annual basis.
Low risk:If you are mindful of buying Non Convertible Debentures of only highly rated companies, then you can be assured of minimal risk of default. It is advisable to opt for secured NCDs.
Liquidity:Non Convertible Debentures carry a high degree of liquidity. These instruments can be easily traded in the open market. Not only can you engage in the outright sale of NCDs in the stock market, you can also opt for options contracts to secure your position in such investments.
No tax burden:Another benefit of investing in NCDs is that there is no upfront tax on the purchase of these instruments (under Section 193 of the Income Tax Act, 1961).
How does NCD Taxation work?
As discussed above, there is no tax to be paid on the purchase of Non-Convertible Debentures. However, the sale of NCDs has some tax implications.
Tax on the sale of NCDs within a year:The sale of Non Convertible Debentures within a year of their purchase attracts Short Term Capital Gain Tax at the applicable slab rate.
Tax on the sale of NCDs post one year but before maturity:The sale of a Non Convertible Debenture a year after its purchase is subject to a Long Term Capital Gain Tax of 20% (with indexation).
Tax on the Interest Income from NCDs:The interest income from Non Convertible Debentures is taxed akin to income from fixed income securities. This income is categorised as 'income from other sources'.
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