Non-Convertible Debentures (NCDs) are fixed income products with a specific tenure and stipulated rate of interest income. It is issued by companies to raise long term funds through public issue without reducing the equity stake as these debentures cannot be converted. On maturity the principal amount along with accumulated interest is paid to the holder of the instrument.
- Credit Risk
As per SEBI mandate, public issue of all NCDs needs to be compulsorily rated by a Credit Rating Agency (CIRISL, CARE, ICRA, etc) and are subject to revisions regularly. The ratings obtained should duly form a part of the prospectus. Securities with AAA rating denote highest level of security and low chances of default on future payments; as the ratings deteriorate, the credit risk increases.
- Interest Rates
Securities that carry high credit risk offer higher interest rates to lure investors and vice versa. Interest payout may be available on monthly, quarterly, half yearly or on annual basis, as per the discretion of the issuers. Most of the NCDs also offer cumulative or interest and growth based option.
Compared to risk free debt instruments (FDs and Government securities) that offer maximum of 7-8% annual returns, NCDs offer a premium of 2-3% above the risk free returns.
- Tax Implications
1) Held till Maturity:
In case you hold the NCD till maturity the Interest earned through NCDs during the year are clubbed with your total income and hence it is entirely taxable as per your income tax slab.
2) If the listed NCD is sold before maturity:
• Short Term Capital Gains (STCG) will be applicable if listed NCDs are sold before 1 year from the date of purchase. Taxation will be applicable as per your income tax slab rate.
• Long Term Capital Gains (LTCG) will be applicable if listed NCDs are sold after 1 year but before maturity. Taxation will be applicable at 10% without the benefit of indexation.Probability of capital gains/loss:There is no possibility to earn capital gains or incur capital loss when NCD’s are held till maturity. However, when interest rates fall or increase, the value of listed NCDs accordingly changes. When interest rate falls, bond prices go up resulting in capital (The price of the listed bond increases) and vice versa.
NCDs are like tortoises, they deliver small but steady returns over time. In India, NCDs are typically issued for a minimum 90 days. While investing in NCDs, investors need to look beyond the nominal returns. It’s imperative to check the issuer company’s background and if it has successfully repaid its previous debts in the stipulated period. Equal weightage must be given to post tax return, credit rating, liquidity, ability of the company to honor future commitments and also the tax impact that can affect the overall financial strategy of the individual.