Non Convertible Debentures (NCD): Meaning, Taxation, Interest Rate, Example

Non-convertible Debtentures (NCDs) are a type of investment in which you lend money to a company and get paid interest in return. Unlike some other investments, NCDs cannot be changed into company shares. They are safe and give good returns, making them popular for people who want a steady income with low risk. This article explains NCDs, covering what they are, how they work, their benefits, risks, and tips for investing wisely.

What Are Non-Convertible Debentures (NCDs)?

NCDs are like loans you give to a company. In return, the company pays you interest regularly, every month, every three months, every six months, or once a year. When the NCD reaches its end date (called maturity), you get back the money you invested plus any final interest. For example, if you invest ₹10,00,000 in an NCD with 9% interest for three years, you could earn ₹90,000 yearly and get ₹10,00,000 back at maturity.

Companies issue NCDs to collect money for business needs, like building factories or expanding operations. In India, these NCDs are regulated by the Securities and Exchange Board of India (SEBI), which ensures companies follow rules to protect investors. A Debenture Trustee, appointed by the company, also watches over the process to ensure investors are treated fairly.

Types of NCDs

In the Market, there are two types of NCDs traded, such as,

Secured NCDs: 

These are safer because they are backed by the company’s assets, like buildings or machinery. If the company cannot repay you, these assets can be sold to return your money. However, secured NCDs offer lower interest rates.

Unsecured NCDs: 

These are riskier because assets do not back them. If the company fails to pay, you may have to wait longer to get your money. To make up for the risk, unsecured NCDs offer higher interest rates.

Factors to Consider Before Investing in Non-Convertible Debentures

Before investing, check these points:

• Credit Rating: Pick companies with high ratings (AA or AAA) from agencies like CRISIL or CARE. Higher ratings mean the company is financially strong and less likely to default.
• Debt Levels: Avoid companies with too much debt (more than 50% of their assets). High debt means higher risk.
• Capital Adequacy Ratio (CAR): Choose companies with at least 15% CAR, showing they have enough funds to handle losses.
• Non-Performing Assets (NPAs): Companies should set aside at least 50% of their assets for bad loans. This shows they manage risks well.
• Interest Coverage Ratio (ICR): A high ICR means the company can easily pay interest on its loans, making it safer.
• Your Tax Slab: NCDs are best for people in lower tax slabs (10% or 20%) because taxes reduce your returns in higher slabs.

Who Should Invest in NCDs?

• Secured NCDs: Best for people who want a safe, steady income, like retirees or cautious investors.
• Unsecured NCDs: Suitable for those willing to take more risk for higher interest.
• Not Ideal For: People in high tax slabs (30%) or those needing quick access to cash, as selling NCDs can be hard.

How to Invest in NCDs

You can buy NCDs in two ways:

During Public Issue: 

Companies announce NCDs, and you can apply through a bank or broker. It’s first-come, first-served, so act quickly.

From the Stock Market: 

After the NCD is issued, you can buy it from stock exchanges through a broker, like Kotak Securities or Zerodha.

You need a demat account (like a bank account for investments) to invest. NCDs are stored in this account, making buying, selling, and tracking easier. If your NCD is in a demat account, you don’t have to pay Tax Deducted at Source (TDS) on the interest.

Steps to Invest in NDCs

• Open a demat account with a bank or broker.
• Check for new NCD issues on stock exchanges or ask your broker.
• Apply for NCDs during public issues or buy from the stock market.
• Keep track of the company’s performance and credit rating after investing.

Benefits of Investing in NCDs

Good Returns: 

NCDs usually offer annual interest between 7% and 10%, which is higher than most bank FDs. That extra yield can appeal to investors who want steady returns without too much uncertainty. It’s a way to earn more without diving into high-risk investments.

Regular Income: 

Investing in NCDs for the sake of regular income. You can get interest monthly, quarterly, yearly, or all simultaneously (called cumulative). These NCDs help investors like you if you need money regularly on a particular periodic basis for your monthly expenses or other purposes.

Tradable: 

You can sell NCDs on stock markets (like NSE or BSE) before they mature, giving you flexibility. However, the selling price may vary based on interest rate changes and market demand. This liquidity feature makes NCDs suitable for investors needing early access to their funds..

Diversification: 

Adding NCDs to your investments (along with savings or stocks) lowers your overall risk. They offer fixed returns that are not directly linked to stock market volatility. This diversification helps balance your portfolio during uncertain or bearish market phases.

Low Risk for Secured NCDs: 

Secured NCDs come with a safety net that the company’s assets back your money.
So, if things go wrong and the company can’t pay, those assets can be used to cover what you’re owed. That extra layer of protection is why many low-risk investors prefer secured options over unsecured ones.

NCDs vs. Corporate Fixed Deposits (FDs)

Tips for Safe NCD Investing

• Check the Purpose: Read the company’s offer document to understand why they issue NCDs. Avoid companies that don’t clearly explain how they will use your money.
• Spread Your Money: Invest in NCDs from companies with different maturity dates to lower risk.
• Avoid Risky Sectors: Don’t put all your money in one sector, like NBFCs giving personal loans, as they can be risky.
• Buy Older NCDs: Older NCDs on the stock market may give better returns if bought at a lower price when new NCDs are issued.
• Sell Smartly: Sell your NCD when its interest is due, as this is when it’s most valuable in the market.
• Watch the Economy: Companies may struggle to pay in tough economic times, increasing the risk. In good times, NCD returns seem less attractive than stocks.

Risks of Investing in NCDs

Company Risk: 

If the company faces financial trouble, it may not pay the interest or return your money, especially with unsecured NCDs. Unlike secured NCDs, there’s no collateral to fall back on in case of default. That’s why checking the company’s credit rating before investing is essential.

Interest Rate Risk: 

If market interest rates rise, your NCD’s market price might fall if you plan to exit early. Buyers prefer newer NCDs with higher payouts, so that older ones may lose value in trading. But if you're holding till maturity, none of that matters, as you’ll still get your promised returns.

Inflation Risk: 

When inflation climbs rapidly, the fixed interest from your NCD might lose its real value.
What seems like a reasonable return today may not keep up with rising living costs.
So while your earnings stay the same, their purchasing power could quietly shrink.

Selling Difficulty: 

NCDs don’t always have enough buyers in the market, making selling tricky. If demand is low when you want to exit, you might have to settle for a discounted price.
NCDs are better suited for those who can hold them till maturity.

Features Of NCDs

Non-Convertible Debentures have a lot of features such as.

Taxation on NCDs

The money you earn from NCDs is taxed in two ways:

• Interest Income: The interest you get is taxed as “income from other sources” based on your income tax slab (10%, 20%, or 30%). For example:
  • If you earn 9% interest (₹90,000 on ₹10,00,000) and are in the 20% tax slab, you pay ₹18000 tax, so your take-home interest is ₹72000.
  • The table below shows after-tax returns for different tax slabs:

Capital Gains: If you sell your NCD before maturity:

• Selling within 12 months (for listed NCDs): Short-Term Capital Gains (STCG) tax applies, based on your income tax slab.
• Selling after 12 months: The Long-Term Capital Gains (LTCG) tax is 12.5% (without indexation).

For cumulative NCDs (where interest is paid at maturity), the entire interest is taxed at maturity based on your tax slab. For example, if you invest ₹10,000 in a 3-year cumulative NCD at 9%, you get ₹12,709 at the end. The interest (₹2,709) is taxed at your slab rate (e.g., 20% tax = ₹541.80).

Call and Put Options

Some NCDs come with special features:

• Call Option: The company can buy back the NCD before maturity, usually if interest rates drop. This may limit your earnings.
• Put Option: You can sell the NCD back to the company at a set price, giving you an exit option if needed.

Check if your NCD has these options before investing, as they affect your returns.

Recovery in Case of Default

If a company cannot pay, secured NCD holders can recover money by selling the company’s assets, with help from the Debenture Trustee. Unsecured NCD holders must wait longer and may not get full repayment, as they have lower priority.

Green NCDs

Some companies issue NCDs for eco-friendly projects, like solar energy. If you care about the environment, look for these “green NCDs” from companies with good sustainability practices.

Understanding Yield to Maturity (YTM)

The interest rate (called the coupon rate) is not the whole story. If you buy an NCD at a price different from its face value (e.g., ₹9,800 for a ₹10,000 NCD), your actual return is called Yield to Maturity (YTM). YTM includes the interest and any gain or loss from the price difference. For example, buying a ₹10,000 NCD at ₹9,800 with 9% interest for 2 years gives a YTM of about 9.5%, meaning you earn slightly more than the 9% interest.

Recent Trends

In 2024-2025 FY, many Non-Banking Financial Companies (NBFCs) like Bajaj Finance issued NCDs offering 8-9% interest, attracting retail investors. However, new SEBI rules are making it harder for smaller NBFCs to issue NCDs, which may reduce investors' options.

Costs to Know

Investing in NCDs involves small costs:

• Brokerage Fees: You may pay 0.5-1% when buying or selling NCDs on the stock market.
• Demat Charges: Annual fees for maintaining a demat account (₹300-₹1,000, depending on the broker).

Conclusion

NCDs are a great way to earn a steady income with moderate risk, especially if you choose secured NCDs from strong companies. Always check the company’s credit rating, debt levels, and financial health before investing. Spread your money across different NCDs and monitor economic trends to make wise choices. If you’re new to NCDs, start with a demat account and consult a trusted broker to guide you.

Disclaimer: Information provided is only for educational purposes. Check stock exchanges (NSE/BSE) or ask your broker for more details on recent NCD issues. If you have questions, talk to a financial advisor to ensure NCDs fit your goals.