In continuation of part 1: Should You Invest in NCDs? in which I explained the reasons behind immense popularity of Non-Convertible Debentures (NCDs) and how to invest in them, this post answers some oft-repeated questions about NCDs: what is a NCD? How is it different from a FD? What are the tax implications of investing in NCD? What are the risks involved in investing in NCD? Knowing the answers to these frequently asked questions (FAQs), will help make the investment decision easier for you.
NCDs -Top 10 FAQs
1. What are NCDs?
Non-convertible debentures (NCDs) are debt instruments with a fixed tenure issued by companies to raise money for business purposes. Unlike convertible debentures, NCDs can’t be converted into equity shares of the issuing company at a future date.
2. What’s the difference between NCDs & FDs?
Following are the differences between an NCD and an FD:
i). Liquidity: In contrast to a NCD, FD can’t be sold in the market. As NCDs are listed on a stock exchange, you can sell them any time you want. However, bank FDs are also highly liquid and can be encashed before maturity with minor penal charges.
ii). Safety: While NCDs are secured debt, corporate FDs are altogether unsecured and bank FDs are secured to the extent of Rs one lakh only.
iii). Taxation: There is difference in taxation aspect also. In addition to interest income, there can be capital gains if you sell the NCD before maturity. However, unlike FDs, there is no TDS in case of NCDs.
iv). Interest rate risk: Unlike FDs, NCDs carry interest rate risk due to changes in market interest rates.
3. Is investing in NCDs better than parking funds in corporate and Bank FDs?
NCDs vs. Corporate fixed deposits: Yes, of course NCDs are better than company FDs for the above stated reasons. Though usually the interest rates on NCDs and company FDs are more or less the same, what tilts the balance in favour of NCDs is the risk-return factor. Furthermore, there is also potential to earn capital appreciation from NCDs if there is a downward movement in the interest rates.
NCDs vs. Bank fixed deposits: Again, NCD is better than a bank FD because the interest differential is quite significant which comes at just a slightly higher risk. In other words, risk-return ratio is in favour of NCDs.
4. From companies point of view, FDs are better than NCDs? So, why do TATA CAPITAL & Shriram Transport came up with NCDs and not FDs? In other words, why only NBFCs are issuing NCDs while manufacturing companies (TATA Motors issued FDs alongside the TATA CAPITAL NCD issue in Feb 2009) prefer issuing FDs?
Simply, because some NBFCs are not allowed to issue fixed deposits. Why?
In 2009, till date there are only two issues of NCDs. First NCD issue was by TATA CAPITAL (TCL) in Feb 2009 and the second was by Shriram Transport in July 2009. Please note that both the companies are registered as ‘non-deposit taking NBFCs’ and therefore are not allowed to issue Public deposits / Fixed Deposits as per RBI guidelines.
5. What are income tax implications? How the returns from NCDs are taxed?
There can be two types of income from NCDs:
First is the interest income from a NCD and tax treatment is exactly similar to any other interest income such as interest income from FDs. In other words, interest income from NCDs will be subjected to tax at normal rates by including it in ‘Income from other sources’.
Next is capital gains. If you decide to sell the NCDs on the stock exchange, capital gains can also arise. If NCDs are sold with in a period of 12 months from the date of allotment, short term capital gains / loss (STCG) will arise and if you decide to sell NCDs after a period of 12 months, the resulting gain or loss is called long term capital gains / loss (LTCG).
While short term capital gains on sale of NCDs would be taxed at normal rates, long term capital gains on sale of NCD (a listed security) are taxed at concessional rates u/s 112 of IT Act.
Long term capital gains on listed securities are taxed at the rate of 10% without indexation or 20% with indexation whichever is lower. However, as the benefit of cost indexation is not available in case of bonds and debentures; therefore, long term capital gains from NCDs are always taxable @ 10.30 per cent (including education cess of 3%) without indexation.
6. Why there is no TDS on interest income from NCDs?
As per changes made by budget 2008 in section 193 of the IT Act, w.e.f. June 1 2009, there is no tax deduction at source from any securities issued by a company in a dematerialized form and listed on a recognized stock exchange in India.
As both the recent issues of NCDs were compulsorily in the DMAT form and listed on the NSE, so there is no TDS applicable on them.
However, NCDs allotted to non-resident Indians (NRIs) will be subject to tax deduction at source as per section 195 of the Income Tax Act.
7. Whether NRIs can invest in NCDs?
Yes, NRIs can invest in NCDs provided the company issuing NCDs allows them to invest in it. For instance, unlike TATA CAPITAL NCD offer, Shriram Transport NCD offer was also open for non-resident Indians (NRIs).
8. Do we require a DMAT account for investing in NCDs?
Yes, because all the recent issues of NCDs were compulsorily in the dematerialized form.
9. Is PAN also mandatory?
Yes, quoting PAN number in the NCD application form is compulsory irrespective of the amount involved as per SEBI guidelines.
10. Can I invest in NCDs through stock exchange?
Yes, of course you can invest in NCDs once they start quoting at the stock exchange. For example TATA NCDs are listed on both NSE as well as BSE.
The NSE codes are TATACAPNI, TATACAPN2, TATACAPN3 and TATACAPN4. The BSE symbols of the TATA Capital NCD are as follows: scrip ID is TCAPNCDI, TCAPNCDII, TCAPNCDIII and TCAPNCDIV and scrip codes are 934777 to 934780. To view the current quotes of TATA Capital NCD on NSE, open nseindia.com and enter TATACAP in the ‘Get Quote’ box.
However, please note that you won’t get them at the face value due to fluctuations in the market interest rates which affect the prices of NCDs. For example, TATA Capital NCD is currently quoting on NSE at (closing price as on 20 August 2009) Rs 1101.76 (N2), Rs 1121.76 (N3) and Rs 1124.37 (N4). The BSE closing prices of the NCD as on August 20, 2009 are Rs 1092.10 (TCAPNCDII), Rs 1129 (TCAPNCDIII) and Rs 1123.85 (TCAPNCDIV). There was no trading in NCD option1 (monthly interest payment option with a face value of Rs 1 lakh) on both NSE and BSE (TATACAPNI / TCAPNCDI) on August 20, 2009.
Next part (part 3) will take a peek at various risks factors affecting NCDs. Meanwhile, if you got any questions to ask, write them in comment box.
1. Should You Invest in NCDs?