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. These are safe and give good returns, making them popular for people who want a steady income with low risk. Let’s check out 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. 

Companies issue NCDs to raise capital for business needs, such as 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.

Example: you invest ₹10,00,000 in an NCD with a 9% interest rate for 3 years; you could earn ₹90,000 per year and get ₹10,00,000 back at maturity.

Types of NCDs

Non-Convertible Debentures (NCDs) are primarily classified as secured or unsecured and may offer fixed or floating interest rates. They provide regular income or lump-sum payments. Key variations include callable and puttable options.

Based on Security:

• Secured NCDs: These are backed by the issuer's assets (collateral). If the company defaults, investors can recover their money by selling these assets, thereby reducing the risk.
• Unsecured NCDs: These have no collateral backing and depend solely on the issuer's creditworthiness. They carry a higher risk but typically offer higher interest rates compared to secured NCDs.

Based on Interest Payout:

• Cumulative NCDs: Interest accumulates and is paid along with the principal amount at maturity.
• Non-Cumulative NCDs: Interest is paid at regular intervals (monthly, quarterly, or annually).

Based on Interest Rate:

• Fixed-Rate NCDs: The interest rate remains fixed throughout the investment's tenure.
• Floating-Rate NCDs: The interest rate fluctuates in line with market benchmarks.

Based on Redemption (Call/Put Options):

• Callable NCDs: The issuer has the right to redeem or call the debentures before maturity.
• Puttable NCDs: The investor has the right to require the company to redeem the debentures before maturity.

Based on Registration:

• Registered NCDs: The company maintains a register of holders, and only the registered person receives payments.
• Bearer NCDs: These are transferable by delivery, and the holder in possession is entitled to payments. 

NCDs are generally listed on stock exchanges to provide liquidity and have tenures ranging from 90 days to 10 years. 

Factors to Consider Before Investing in NCDs

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 indicates the company can easily cover its interest payments, 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 stockbroker.

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 rates of 7% to 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 at once (cumulative). These NCDs help investors like you who need money regularly, on a set periodic basis, for monthly expenses or other purposes.

Tradable: 

You can sell NCDs on stock markets (such as NSE or BSE) before they mature, giving you greater flexibility. However, the selling price may vary with changes in interest rates 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, such as NBFCs that offer 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, and the return that seems reasonable 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 often don’t have enough buyers in the market, making sales 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. 

Example: If you invest ₹10,000 in a 3-year cumulative NCD at 9%, you will receive ₹12,709 at maturity. 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, typically when interest rates decline. This may limit your earnings.
• Put Option: You can sell the NCD back to the company at a set price, providing an exit 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 their money by selling the company’s assets with the help of 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 interest and any gain or loss from price differences. 

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 the 2024-2025 FY, many Non-Banking Financial Companies (NBFCs) issued NCDs offering interest rates of 8-9%, attracting retail investors. However, new SEBI rules are making it harder for smaller NBFCs to issue NCDs, potentially reducing 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.