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

Non-Convertible Debentures (NCDs) are fixed-income instruments where investors lend money to companies in exchange for regular interest payments and principal repayment at maturity. Companies commonly use them to raise funds, and investors use them to earn stable returns.

Key Highlights:

• NCDs are financial securities paying interest income regularly.
• The interest income is taxable at your income tax rate, and capital gains tax applies when sold.
• The NCDs pay interest ranging from 7% to 10%.

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 mainly categorised as secured or unsecured and can offer you either fixed or floating interest rates. They provide regular income payouts or a lump-sum return at maturity, with key variants that include callable and puttable options. 

Based on Security

• Secured NCDs: The company's assets are mostly used as collateral for these. If the issuer defaults, investors can get their money back by selling these assets, thereby reducing risk.
• Unsecured NCDs: Unsecured NCDs lack collateral and primarily depend on the issuer's creditworthiness. They are riskier, but they usually have higher interest rates than secured NCDs.

Based on Interest Payout

• Cumulative NCDs: Interest accumulates and is paid along with the principal at the loan's maturity.
• Non-Cumulative NCDs: Interest is paid regularly, such as monthly, quarterly, or annually.

Based on Interest Rate

• Fixed-Rate NCDs: The interest rate remains fixed throughout the entire 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 can redeem the debentures before maturity
• Puttable NCDs: The investor can ask the company to redeem the debentures before maturity.

Based on Registration

• Registered NCDs: The company keeps a record of holders, and payments are made only to registered investors.
• Bearer NCDs: These can be transferred by delivery, and whoever holds them receives the 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 to get a better understanding:

• Credit Rating: Choose companies with high Credit ratings (AA or AAA) from agencies like CRISIL or CARE. Higher credit ratings demonstrate that the company is financially strong and less likely to default in future.
• 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 more suitable for investors in lower tax slabs (10% or 20%), as higher tax rates can reduce overall returns.

Who Should Invest in NCDs?

The right type of NCD depends on your risk appetite, income needs, and investment goals. While secured NCDs are better suited for conservative investors, unsecured NCDs may appeal to those seeking higher returns and willing to take on additional risk. 

Secured NCDs

Most appropriate for conservative investors, retirees, and people looking for a stable and dependable stream of income. 

Secured NCDs, backed by the assets of the issuer, tend to provide more security than unsecured NCDs and are therefore appropriate for people with low-risk profiles.

Unsecured NCDs

Appropriate for people with high-risk profiles who are willing to take up extra risks to earn extra returns in terms of interest rate. 

Unsecured NCDs would be more appropriate for people who are already familiar with the issuer's credit profile.

Not Ideal For

NCDs might not be appropriate for people who belong to the highest income tax slab because the interest returns will be taxed at the rate applicable to the person's income tax slab.

 NCDs might not be appropriate for people who might require the money urgently because it is quite tough to sell the NCDs on the stock exchange.

How to Invest in NCDs?

You can buy NCDs in two major ways, either by public issue or through the stock market, the steps are mentioned in detail below:

Public Issue

Companies announce NCDs, and you can apply through a bank or a broker. Steps are mentioned below.

• Verify the specifics of the NCD issue, like the interest rate, tenor, credit rating and whether it is a secured or unsecured NCD.
• Open a Demat account if you do not have one.
• Log in to your bank’s ASBA portal or stockbroker website.
• Choose the NCD public issue and the series you prefer.
• Enter the amount you want to invest and submit your application.
• Your allotted NCDs will be received in your Demat account after the issue closes.

Stock Market

To invest in NCDs, you need a demat account to hold them digitally, making transactions and tracking easy, and it also helps avoid TDS on interest.

• Open a trading and Demat account with an SEBI-registered broker.
• Log in to your trading account and search for the NCD listed on the stock exchange.
• Verify the NCD’s price, yield, maturity period and credit rating.
• Enter the quantity of NCD you want to buy.
• Place a market/limit order to buy NCD.

Benefits of Investing in NCDs

Here are the key benefits of investing in NCDs:

• Stable  Returns: NCDs offer interest rates of 7% to 10%, which are often higher than bank FDs, making them more attractive for investors seeking steady returns without taking on too much uncertainty 
• 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: NCDs can be sold on the NSE or BSE before maturity, offering flexibility, though prices may vary with interest rates and market demand.
• Low Risk for Secured NCDs: Secured NCDs are safe because the company's assets back your money. If something goes wrong and the company can't pay, those assets can be used to pay you what you owe. Many low-risk investors choose secured options over unsecured ones because they offer an extra layer of protection.

Corporate Fixed Deposits (FDs) vs NCD's

Both Corporate Fixed Deposits and Non-Convertible Debentures are fixed-income investments that provide steady returns. Below are some differences to help you choose an option based on your needs.

Tips for Safe NCD Investing

Before investing in NCDs, it’s important to follow a few simple checks to reduce risk and make informed decisions:

• 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 into a single 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

Before investing, it’s important to understand the potential downsides involved:

• Company Risk:  If a company faces financial trouble, it may fail to pay interest or return your investment, especially with unsecured NCDs. Since there’s no collateral backing them, the risk is higher, making it important to check the company’s credit rating before investing.
• 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 those matters, as you’ll still get your promised returns.
• Risk of Inflation: When inflation rises quickly, the fixed interest from NCDs loses real value. The returns that look good today may not keep up with rising living costs. Because of this, your income stays the same, but your buying power slowly goes down.
• Selling Difficulty: This occurs when there aren't many buyers for NCDs, making it hard to sell. If demand is low when you want to sell, you might have to sell for less, which makes them more attractive to investors who can hold until they mature.

Features Of NCDs

There are some important characteristics of non-convertible debentures that investors should know before investing. The characteristics include:

• Fixed Interest Return: NCDs provide a fixed or floating rate of interest to the investors.
• Cannot Be Converted into Equity Shares: Unlike convertible debentures, non-convertible debentures cannot be converted into equity shares.
• Fixed Tenure of Issue: They are paid back on a fixed tenure of issue.
• Higher Returns: Non-convertible debentures earn relatively higher interest compared to fixed deposits.

Tradable at Stock Markets: Listed NCDs can be traded in stock markets.

Taxation on NCDs 

The returns earned from NCDs are taxed as interest income and capital gains. The tax treatment depends on whether you earn interest or sell the NCD before maturity.

Tax on Interest Income

Interest earned from NCDs is taxed under "Income from Other Sources" and is added to your total taxable income. It is taxed according to your applicable income tax slab.

For listed NCDs held in demat form, issuers generally do not deduct TDS on interest payments. However, the interest remains fully taxable and must be reported while filing your income tax return.

Example: Suppose you invest ₹10,00,000 in an NCD offering 9% annual interest.

• Annual interest earned: ₹90,000
• If you fall under the 20% tax slab:
  • Tax = ₹90,000 × 20% = ₹18,000
  • Post-tax interest = ₹72,000

After-Tax Returns

Note: Tax payable may also include applicable surcharge and 4% Health & Education Cess.

Tax on Capital Gains

If you sell a listed NCD before maturity:

• Held for up to 12 months: Short-Term Capital Gain (STCG) taxed at your applicable income tax slab.
• Held for more than 12 months: Long-Term Capital Gain (LTCG) taxed at 12.5% without indexation.

Example: You buy a listed NCD for ₹1,00,000 and sell it after 15 months for ₹1,12,000.

• Capital Gain = ₹12,000
• LTCG Tax = ₹12,000 × 12.5% = ₹1,500

Unlisted NCDs: Capital gains on transfer, redemption, or maturity are treated as STCG, irrespective of the holding period, and taxed according to your income tax slab.

Taxation of Cumulative NCDs

In cumulative NCDs, interest is paid along with the principal at maturity. The accumulated interest is taxable as "Income from Other Sources" at your applicable income tax slab.

Example: You invest ₹10,000 in a 3-year cumulative NCD at 9%.

• Maturity Amount: ₹12,709
• Interest Earned: ₹2,709
• If you are in the 20% tax slab, tax payable = ₹541.80 (excluding surcharge and cess).

Note: If a Non-Convertible Debenture (NCD) is market-linked (MLD), any gains arising on its transfer, redemption, or maturity are always treated as Short-Term Capital Gains (STCG) under the Income-tax Act, irrespective of the holding period. Such gains are taxed at the investor's applicable income tax slab rate. 

Call and Put Options in NCD's

Some NCDs come with special features:

• Call Option:  The company can redeem the NCD before maturity, usually when interest rates fall.
• Put Option: You can sell the NCD back to the company at a predetermined price, offering an exit when 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) in NCDs

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 FY 2024–2025, many Non-Banking Financial Companies (NBFCs) issued NCDs with interest rates of 8–9%, attracting retail investors. But new SEBI rules are making it harder for smaller NBFCs to issue NCDs, which limits investors' choices.

Costs Involved

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

If you choose to invest in secure opportunities offered by reputed firms, NCDs ensure constant income with low risk. You must always ensure that your financial standing is in order before making any investments. This way, you can earn greater profits.