Bad news – Bank FD interest rates are coming down – first declared by PSU banks and now by Pvt. Sector banks. Corporates whose FDs are open are likely to follow the suit soon.
Good news – Corporates NCDs have started pouring in and offering interest rate ranging between 11 – 12.75% p.a. for 3 – 5 year term. First Shriram Transport Finance Corporation, then India Infoline Finance Ltd, followed by Shriram City Union Finance, Religare FinVest, Muthoot Finance and some more to come.
Salient features of NCD:
If you just look carefully at each word in the advertisement of any ongoing NCD, you can find a lot about the nature of such instrument. Let us look a little deeper into the text of Shriram City Union Finance’s NCD advertisement.
It says: “Public Issue of Secured Redeemable NCDs rated ‘CARE AA’ & ‘CRISIL AA-/Stable’ by CRISIL”
What you can make out from the above line – a lot. Let us go word-by-word.
“Public Issue” – A company can raise money (mostly for its expansion) in various ways – issuing shares i.e. by going public or getting listed, borrowing from different lending institutions – banks or NBFCs, through corporate fixed deposit or issuing NCDs etc. In most of the cases except in issuing shares, company agrees to pay a fixed interest rate to the lender for a pre-determined tenure. An NCD is no different.
“Secured” – An NCD can either be secured or unsecured. In case of secured NCDs, these are backed by certain fixed assets of the company. So in case the issuer i.e. the company is not able to fulfil its obligation, the assets are subject to get liquidated to repay the investors like you and me who are holding the debentures. This is very important for us to make sure that the NCD is secured at the first place.
“Redeemable” – NCDs are listed on stock exchanges. Therefore you are allowed to liquidate your holdings i.e. to sell your NCDs before maturity – thus these NCDs are redeemable. But here is a catch – there is not much activity noticed in the wholesale debt market segment of the stock exchanges, where these NCDs are listed. Hence in most cases you may not be able to find a buyer. So though there is liquidity it is difficult to implement.
“NCD” – stands for Non-Convertible Debentures which clearly signifies that these debentures will not get converted into shares of the issuing company.
“Rated” – Companies seeking to raise money through NCDs have to get their issue rated by rating agencies such as CRISIL, ICRA, CARE and Fitch Ratings. NCDs with higher ratings are safer and carry lower default risk. Rating is also equally important along with the ‘secured’ tag to decide whether to invest in an NCD or not.
Taxation
There are three things that you would possibly do with your NCD and the respective tax implications are as follows:
1) You are holding the NCD till maturity – Interest earned through NCD is then clubbed with your income and taxed as per your respective income tax-slab.
2) You are selling the NCD within a year – If you sell your NCDs on the stock exchange before a year then you will have to pay short-term capital gains at income-tax rates applicable to you.
3) You are selling the NCD after a year but before maturity – If the debenture is encashed after one year but before its maturity, you will have to pay long term capital gains tax on the effective return. This is at the rate of 10% without indexation or 20% with indexation, which factors in inflation.
There are some another feature in the advertisement that catches our attention also:
“No Tax Deduction at Source on interest on NCDs held in dematerialized form” –
Make no mistake here. This is not saying that you will need to pay tax, all it is saying is that tax would not be deducted at source. You are supposed to declare / mention this interest income (deemed or received) while filing your return. But lat part of the above statement is an important add-on – ‘dematerialized form’. Holding a fixed income instrument in dematerialized form is of so much convenience and makes your book-keeping exercise easier.
All said and done – should you invest in any such NCD now? Ok, do not look further for this answer, the answer lies in your strategy document or the financial plan. Products will come and go, and you are not supposed to take note of each of such events and spend hours pondering whether to go for it or not. Instead such strategy-shift should have been well documented before hand in your financial plan or in the subsequent reviews.
Don’t jump the gun, aim it first!