Taxation on Non-convertible debentures (NCDs)

“Dive into the world of Non-Convertible Debentures (NCDs) and understand the taxation implications. Explore the types, features, advantages, and disadvantages. Stay informed to make sound investment decisions.”

Non-convertible debentures (NCDs) are fixed-income securities typically issued as a public offering by highly rated corporations to build up long-term capital gains. They provide slightly higher interest rates than convertible debentures.

Debentures that are not convertible come into this group. They are not convertible into stocks or equity. Non-Convertible Debenture have a set maturity date, and depending on the fixed term selected, the interest can be paid either monthly, quarterly, or annually together with the principle. When compared to convertible debentures, they provide investors superior yields, liquidity, low risk, and tax advantages.

When businesses need to raise fixed-maturity market capital, they issue non-convertible debentures. From 90 days to 20 years might be used as the maturity period.

Types of Non-convertible Debenture

Secured

Because their issues are backed by the company’s assets, secured NCDs are regarded as being the safer of the two types. If the company doesn’t make payments on time, the investors may recover their money by selling off the company’s assets. On Non-convertible debentures (NCDs), however, there is not much interest offered.

Unsecured

The assets of the company do not back unsecured Non-convertible debentures (NCDs), making them much more hazardous than unsecured NCDs. Because the company has no assets to use to pay off their debts, investors are left with little alternative but to wait until they get compensation when the company defaults on a payment. In contrast to secured Non-convertible debentures (NCDs), however, unsecured Non-convertible debentures (NCDs) offer greater interest rates.

Features of Non-convertible Debentures

i. NCDs provide greater interest rates to investors, especially in the case of unsecured NCDs. The interest rate is proportionate to the company’s creditworthiness. When investors take a risk by investing in a lower-rated company, they expect a larger return in exchange for the increased risk.

ii. Debentures are often listed instruments, they can be exchanged in secondary markets. This provides them with the benefit of liquidity.

iii. Investors can purchase NCDs through public offerings. Interest investors can subscribe to these debentures during the time range provided. Investors can subscribe to these debentures through authorized brokers after they are listed on the stock exchange.

iv. These debentures are usually provided to raise financing by reputable companies. If the company fails to pay its obligations to NCD investors, the company’s credit rating would suffer.

Taxes on Non-Convertible Debenture

First, interest income from NCDs has the exact same tax treatment as other interest income, such as interest income from FDs. In other words, by include it in “Income from other sources,” interest income from NCDs will be subject to tax at standard rates.

Capital gains are the next. Capital gains might come from selling the NCDs on the stock exchange. Short term capital gains or losses (STCG) will occur if NCDs are sold within 12 months of the date of allotment, while long term capital gains or losses (LTCG) will occur if NCDs are sold after the 12-month mark.

While long-term capital gains on the sale of NCDs (a listed securities) are taxed at preferential rates under Section 112 of the IT Act, short-term capital gains on the sale of NCDs would be subject to standard rates of taxation.

The tax rate for long-term capital gains on listed stocks is either 10% without indexation or 20% with indexation, depending on which is lower. However, as bonds and debentures do not benefit from cost indexation, long-term capital gains on NCDs are always subject to a 10.30% tax without indexation (including a 3 percent education cess).

What are the factor considering before Investing in Non-Convertible Debenture 

i. Credit Rating:- Credit ratings for NCDs are provided by Agencies. Higher risk is indicated by a lower rating, and vice versa. The greater the rating, the safer the NCD. The same is true for Secured NCDs and Unsecured NCDs.

ii. Company Background:- Before making any investment decision, it is important to carefully consider the credit, payback history, and other company the fundamentals.

iii. Liquidity:- Since NCDs are listed on the stock market, they are liquid. They may have a provision that enables you to leave early, such as a PUT Option. After the lock-in period, which can be longer than 90 days, this option may be exercised.

iv. Taxation and TDS:- Other than tax-free bonds, NCDs are taxed based on each taxpayer’s personal tax bracket under the heading “Income from Other Sources.” There are no TDS requirements for all NCDs listed on the stock exchange. Investors that withdraw their money from the NCD before a year are subject to short-term capital gains tax. Investors who withdraw their money after a year but before the maturity date are taxed on their long-term capital gains.

v. Rate of returns:- Usually, NCDs offer a higher rate of return than other debt vehicles. At this time, the return rate is between 10%

vi. Interest Payout:- It can be quarterly, half-yearly, annual, or cumulative, depending on the investor’s preferences. The cumulative choice is the greatest since the interest is reinvested and the investor makes money. However, the decision remains with the investor and is determined by his investing objectives.

What are the Advantage and Disadvantage of Non-Convertible Debentures

Advantage

i. Interest rates on these debentures are greater than on convertible debentures and fixed deposits.

ii. In the event of insolvency, the business has a duty to pay NCD(Non-Convertible Debenture) holders first, followed by equity holders. As a result, they are a safe investment alternative.

iii. Every company intending to generate money by issuing NCDs must go through rating agencies and others to validate the information supplied.

iv. NCDs are traded on a stock exchange, providing investors with liquidity. As a result, investors can buy and sell in the secondary market.

v. TDS is not levied on interest generated on NCDs. When filing income tax returns, interest income is added to total income.

Disadvantage

i. Unlike convertible debentures, NCDs cannot be converted into firm equity shares after a set length of time.

ii. Companies with poor credit ratings are issuing NCDs with higher interest rates. These corporations, however, may default on their payments at maturity, damaging their financial standing.

iii. Secured creditors are paid first in the event of bankruptcy. As a result, unsecured debenture holders will have to wait for their payments.

iv. Unsecured NCD holders risk not getting their principle and interest.

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The above article has been written by Mr. Sachin Vishwakarma (CA Aspirant) and reviewed by Mr. Suyash Tripathi (Chartered Accountant) and they can be reached at sachinvishwakarma155638@gmail.com and tripathi.r.suyash@gmail.com.