What are NCDs? Details – Types – Taxation – Options – Capital Gains

Non-convertible Debentures (NCDs) are debt instruments with a fixed tenure issued by companies to raise funds from the market for business purposes. Unlike convertible debentures, NCDs cannot be converted into equity shares of the issuing company at a future date. Hence, the return offered by them is relatively higher than convertible debentures. The issuing company pays a fixed rate of interest for the pre-defined period.

Cumulative vs Regular Payout NCD:

In case of Regular Interest Payout, the interest is paid at different time periods, say, quarterly, semi-annually and annually. Some debentures also have cumulative option i.e. interest on them is cumulated and paid on maturity. These debentures can be redeemed after a specified time period so the amount invested, which is equal to the face value, will be returned to the investor. These are the good investment option for people who are looking beyond the fixed deposits and other small savings instruments or for those who want to create a diversified debt portfolio by investing in different instruments.

Secured and Non Secured NCDs:

Non Convertible Debentures are generally classified as secured and unsecured based on security of invested amount. Secured NCDs are secured by a charge on the assets of the company. The holders of secured debentures have the right to recover their principal amount and the unpaid amount of interest on such debentures out of the assets mortgaged by the company. Unsecured NCDs do not carry any security with regard to the principal amount or unpaid interest.

Listing & Liquidity:

Debentures can be listed on a stock exchange, providing opportunities to accumulate additionally or to sell them and exit earlier than the tenure of the debenture. But investors have to be careful about the price movement of the instruments, which in turn depends upon the interest rate movements and the applicable coupon interest rate payable on them.

Tenure:

Redemption periods usually range from 3-15 years. However, put and call options are the added features, which can be exercised after three years in longer tenure bonds.

Options: There are embedded options such as Put and Call attached to NCDs.

Call Option: A callable bond could be called or redeemed by the issuer before the maturity of the bond. Issuer will call away the bond when the bond was issued in a high interest rate environment and interest rates fall subsequently. Investor will lose the high interest or coupon payments and will be left with redemption proceeds to be invested in a lower interest rate environment.

Put Option: A putable bond works in an exactly opposite way where the investor can sell the bond to the issuer at a specified price before the maturity of the bond if the interest rates go up after the issuance and investor has higher yielding investment options available.

Callable bonds are preferred by the corporation while investors prefer putable bonds. All things equal, a callable bond would trade at a lower price than the putable bond.

Tax on NCDs:

For income tax purpose, the NCDs are treated like debt instruments.

Interest: The interest earned would be treated as any other interest (say, from a bank FD). It would be a part of your “Income from other sources”, and would be taxable. No TDS is applicable on debentures if they are listed on stock exchanges and are held in demat form.

Principal: An NCD is a capital asset. If you decide to sell the NCDs on the stock exchange, capital gains can also arise. If NCDs are sold with in a period of 12 months from the date of allotment, short term capital gains / loss (STCG) will arise and if you decide to sell NCDs after a period of 12 months, the resulting gain or loss is called long term capital gains / loss (LTCG).

While short term capital gains on sale of NCDs would be taxed at normal rates, long term capital gains on sale of NCD (a listed security) are taxed at concessional rates u/s 112 of IT Act. Long term capital gains on listed securities (except equity shares) are taxed at the rate of 10% without indexation or 20% with indexation whichever is lower.