NRIs - Tax Planning

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I know that my NRI (non-resident Indian) friends are looking forward to ‘The Money Quest’ to provide them proper guidance regarding their Indian finances particularly tax planning and investment planning. Although there is plethora of online information available on the subject of taxation, investments and foreign exchange management—as you must be quite aware—most of it is either outdated or incorrect.

So, starting with this post, Fisher promises to write at least one post every month to help NRIs (non-resident Indians) to plan and manage their investments, insurance and tax in India. Let’s start with tax planning for NRIs.


NRIs – Tax Planning
As a NRI, you already know that settling abroad doesn’t absolve you from tax liability under the Indian Income Tax Act. However, while it is not possible to completely escape the tax net, there are ways to minimize your tax liability under Indian tax laws.

While planning for your taxes as a non-resident Indian (NRI), you’re concerned with following basic questions:

1.Who is a non-resident Indian (NRI)? How to determine the NRI Status under various Indian Laws?

2. When is an NRI liable for tax in India?

3. When the tax is deducted at source (TDS) from the Indian income of an NRI? Or, what are the withholding tax provisions under Indian tax laws? Is it possible for NRIs to avoid TDS from their Indian Income?

4. If there’s no taxable income in India or if it is below exemption limit, do NRIs still require a PAN (Permanent Account Number) card?

5. What is the procedure for applying PAN card in India?

6. Is there any special tax concessions available to NRIs under the IT Act?

7. What are Tax Treaties or DTAAs? How do NRIs avoid double taxation of Income?

8. If Indian income of an NRI is taxable, is it mandatory to file tax returns in India?

9. How do NRIs file IT returns in India?

10. How to plan residential status of NRIs to minimize tax liability in India?


So, starting with next post, I’ll try to answer the above questions regarding NRI taxation. In next post, I’ll talk about the residential status under Indian tax laws with particular relevance to Indian citizens or persons of Indian Origins (PIO) working abroad.

Stay tuned!

Also see:

1. NRI Bank Accounts – Difference between NRO & NRE

2. NRI Tax Planning - Residential Status (#1)

Revised Cap on ULIP Charges - What a Sham!

As quite expected IRDA eventually bowed to the pressure from life insurance companies and diluted the impact of earlier circular (imposing the cap on ULIP charges) by removing the mortality charges from the cap without reducing the overall ceiling. For detailed version of the original circular and its review, see: Investor’s Reforms (#3) - Cap on ULIP Charges.

Following are the amendments made by the IRDA as per circular no. 20/IRDA/Actl/ULIPs/2009-10 dated 20th August, 2009:

1. Mortality and morbidity charges excluded from the cap. However, the overall cap on ULIP charges (3% for short term ULIPs and 2.25% for long term ULIPs i.e., more than 10 years) remains the same.

2. Uniform sub-limit for Fund Management Charges (FMC) irrespective of ULIP tenor. The revised sub-limit for FMC is 1.35 per cent for all kind of ULIP policies i.e., both ULIPs up to 10 years as well as ULIPs for more than 10 years. Earlier the FMC sub-limit was fixed 1.50% for ULIPs having tenure up to 10 years and 1.25% for ULIPs with tenure of more than 10 years.

3. No surrender charges can be levied from 5th year onwards. This is a new addition but hardly of any significance.

I’ve had doubts about the intentions of IRDA in issuing the earlier circular regarding capping ULIP charges. Why make so much noise when ultimately there’s not going to be any significant change in the current scenario?

Actually, it was a well calculated move designed to fool the gullible consumer / investor into believing that IRDA is fully committed towards safeguarding their interests. In reality, the entire exercise seems to be a shrewd marketing gamble to make ULIPs more popular.

Photo by funadium

Indeed, it is a complete sham because there won’t be any significant increase in the ‘net yield’ or the IRR of the ULIP. Furthermore, due to so many exclusions, the actual expense ratio is in fact going to be lot higher than the prescribed limit of 3% / 2.25% and which you’ll never know initially thereby making a mockery of the transparency.

In my view, at least it should be made compulsory for the ULIP illustrations to show (based on assumed gross yield of 10%) two figures of ‘net yield’, first one in accordance with the circular (i.e., by excluding the exclusions) and second ‘net yield’ by including all the charges (i.e., by also including the excluded charges) in the calculation so that a customer can make an informed decision.

If you can’t reduce the cost, at least make it more transparent. What an impossible demand! Asking for transparency and that too from an insurance industry!

To conclude, it is our folly to equate IRDA with SEBI which is truly an independent regulatory authority working in the interest of the investors.

What do you think?


Also see:

1. Cap on ULIP Charges – Review of IRDA Circular

2. Best ULIPs based on IRR

3. ULIPs – Top 10 FAQs

4. New Tax Code: Impact on Life Insurance

5. Term Plans: Lesser Known Facts

L&T Finance NCD – A Brief Overview

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The latest Non-convertible debenture (NCD) issue by L&T Finance is the third retail issue of NCDs by an NBFC during the year 2009. The first one was by TATA Capital (TCL) in February 2009 and second was by Shriram Transport Finance (STFL) in July 2009.

The basic features of the current NCD issue by L&T Finance remains the same which I’ve already covered in previous posts: ‘Should You Invest in NCDs?’ and ‘NCDs – Top 10 FAQs’.

Here in this post, a comparison of L&T Finance NCD issue is made with the previous two NCD issues to give you a better perspective.


L&T Finance NCD offer: Comparison with Previous NCD issues

1. Returns: As expected, with every new issue of NCD, yield is coming down. TCL offered a YTM of 11.57% to 12% and subsequently Shriram Transport (STFL) offered a yield to redemption of 10.75—11.50%. And now L&T Finance NCD effective yield is in the range of 9.85—10.50%. Still the yields are quite attractive when compared to bank fixed deposits (FDs). The current interest / coupon rate differential between a NCD and a bank’s FD is around 2—2.5 per cent.

2. Tenure: While both the previous issues of NCDs allowed you to invest for a maximum period of 5 years, L&T Finance NCD is also offering you longer durations. So, if you wish you can lock-in for a period of 88 months (7-Yr 4 months) or 10 years at high rate of interests. Second, the minimum duration of investment is also higher 5 years as compared to 3 years in earlier issues.

3. Put/ Call Option: Unlike TATA Capital NCD issue in which all the four investment options had put/call option attached and Shriram Transport Finance NCD issue where two investment options out of the five had put and call option, the latest NCD issue by L&T finance doesn’t have any Put and call option clause.

4. NRIs: Similar to TATA Capital NCD issue, L&T Finance is also not offering the NCDs to non-resident Indians (NRIs). However, Shriram Transport Finance NCD had some portion reserved for NRIs.

Rest almost everything is same including good credit rating (AA+ by CARE and LAA+ by ICRA), the L&T Finance NCD issue has received. The offer is open for subscription from August 18, 2009 to September 4, 2009.


Should I invest?
Yes, of course. Go ahead and invest before the yields come down any further.


Also see:

1. Should You Invest in NCDs?
2. NCDs – Top 10 FAQs
3. Interesting Interest Information about FDs

NCDs – Top 10 FAQs

Photo by Chris M *

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.

Also see:

1. Should You Invest in NCDs?

2. L&T Finance NCD - Review

3. PPF Returns Calculator

3. Interesting Interest Information about FDs

Investing in Bank FDs – Interesting Interest Information

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In India, bank fixed deposits (FDs) also called ‘Term Deposits’are still the top-most choice for investing.

While investing in the FDs, an investor has to take into account various considerations such as returns, tax impact, liquidity and safety. But the most important factor among all the variables is the rate of interest offered by a bank on fixed deposit.

Therefore, this post talks about the interest rates offered by various commercial banks on fixed deposits and some interesting information hidden behind the interest rates displayed by them.

For instance, interest rates offered by various banks vary a lot; within a bank there is too much variation in interest rates offered for different durations of deposits; there is also variation in manner of interest calculation for short term and long term tenures of FDs; manner in which interest rates on deposits are displayed also differ among banks and above all the interest rate is not the same thing as yield.

Here’s a list of such interesting facts about interest rates on bank fixed deposits (FDs) which ultimately affects the return earned by an investor:


Bank FDs – Interesting Interest Information
1. It is wrong to assume that greater the FD tenure, higher will be the rate of interest. It is not so. Sometimes short duration interest rates are higher than long duration rates (due to tighter liquidity conditions).


2. Even a single day difference in the FD period can make a huge difference in your interest income due to wide variation in the FD interest rates. For instance, let’s say you are planning to invest in two FDs, one for 2 months and another for 3 months and your bank is offering, say, 6% on FDs for the duration of 31-60 days, 6.5% on 61-90 days deposits and 7% for 91-180 days deposits. In this case it would be outright foolish to invest in FDs for 60days and 90 days. It makes greater sense to go for 61 days and 91 days fixed deposits and earn extra interest of 0.5%.


3. Many banks offer special deposit rates for a particular tenure which are quite higher than deposit rates for other durations (both higher as well as lower tenures).

For instance, HDFC bank is currently (as on August 17, 2009) offering following interest rates (p.a.) on FDs:

91 days to less than 6 months 1 day------> 4.50%
6 months 2 days to 6 months 15 days ----> 5.50%
6 months 16 days-----------------------------> 6.00%
6 months 17 days to 9 months 15 days---> 5.50%

Supposing that you’re planning to invest in an FD for 6 months, if you are not careful and fill the FD form for either 6 months or 180 days, you can straightforwardly lose 1.5% p.a. The right choice is to invest in FD for 6 months 16 days.

But why do banks so much juggle with interest rates on fixed deposits? ‘Cost of funds’ simply can’t be the reason. Perhaps, like other financial companies they also practice confusopoly.

So you need to be extra careful. It is always better to check the latest deposit rates online (as the rates are also changed frequently in addition to variation in interest rates for different tenures of FDs) instead of relying on the bank branch officials, who might not guide you properly or in fact misguide you.

4. The interest rates offered on fixed deposits are annual rates (% p.a.). So, if a bank is offering you 7% rate of interest for 90 days deposit, it means that 7% for 365 days to be paid for 90 days i.e., you get 1.726% (7/365*90) for 90 days.


5. The rate applicable for a ‘monthly interest payment’ option is discounted rate over the standard FD rate. For example, if you invest in a FD for one year offering interest @ 12% p.a. (assuming no quarterly compounding) and choose the maturity option, you’ll get interest @ 12%. However, if choose monthly payment option you won’t receive interest @ 1% (i.e., 12/12) per month. Because, if you receive interest @1% per month, the effective annual rate on the FD becomes 12.68 per cent. Therefore, in case of monthly interest payouts, the bank discounts the annual interest rate; in the above example, the discounted rate of interest per month works out to be 0.9488% approximately. If you’ve a fixed deposit of Rs 1 lakh, you will receive monthly interest of Rs 949 and not Rs 1,000. So the total interest to be received by you at the end of one year will be Rs 12,000 for maturity option and Rs 11,388 for monthly payment option.

However, this discounting rule is not applicable if the maturity period itself is of shorter duration. For instance, if the bank is offering, say, 12% p.a. on one month fixed deposit, then you’ll receive interest @ one per cent (12/12) for the one month deposit (i.e., effective rate of interest earned by you is 12.68%).

It follows from the above that, in case of shorter term deposits (i.e., less than one year), your effective rate of interest is more than the stated rate of interest).

Let me explain it in another way. Continuing the above example, when your monthly deposit will mature, you’ll receive Rs 1,01,000. If you again reinvest it for another month, your interest for next month will be Rs 1,010 and if you continue reinvesting at the end of every month (assuming there is no change in interest rates), you’ll finally end up with Rs 1,12,680 in your pocket at the end of one year earning annualized yield of 12.68%.

However, it is not practically feasible even if you keep on reinvesting because of too frequent changes in interest rates. In the above example, the actual returns earned by you at the end of the year will be either greater or lesser than 12.68%.


6. The interest rate offered doesn’t truly reflect your return. The true measure to reflect the returns from FDs is the yield.

For instance, even if the interest rates on two FDs are similar, yield may differ because of frequency of compounding. A 10% rate of interest per annum payable quarterly is better than a same interest rate payable either half-yearly or annually.

In India, most banks offer you quarterly compounding for FDs of greater than 6 months duration and calculate interest at maturity as simple interest for FDs up to 6 months tenure.

The effective yield in case of quarterly compounding (assuming 10% rate of interest) comes to be 10.38%, for half yearly compounding it works out to be 10.25% and for annual compounding it remains unchanged at 10%.

Similarly, if the interest rate of 5.8% p.a. is compounded quarterly then effective yield / annualized yield works out to be 5.927%. However, as per IDBI Bank it is 6.11%.

As per IDBI Bank website (as on 16 August 2009),

“the interest rate for a 2 year + 1day deposit is 5.80% p.a. but the effective yield is higher at 6.11% p.a. on account of reinvestment of interest earned”

Isn’t it outright lie and intentional misleading of investors /customers?

So, again my advice to you is to remain vigilant and not to rely on the banks (or their websites) blindly and either work out your own calculations or cross-verify the information provided to you by them.

For any other doubt regarding working of interest rates on bank fixed deposits, just write in the comment box below.


Also see:

1. 10 Tips for PPF investing

2. Should You Invest in NCDs?

3. Gold ETF – The Best Way to Invest in Gold

4. NCDs - Top 10 FAQs

5. Bank FD: Consequences in case of Death

Hidden Flaws of Spending (# 3): Marketing Gimmicks

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This post is continuation of the series, “Hidden Flaws of Spending: Why do we make Fatal Money Mistakes”. In part 1 & 2, I discussed about individual specific flaws in our spending decisions such as hedonic adaptation, instant gratification, lifestyle inflation, relative wealth and mental accounting.

In this post, I’m going to discuss how corporates also influence our decision making in various subtle manners without us realizing it and consequently we make sub-optimal spending decisions and ultimately waste more of our precious time and hard earned money.

I’m not sure whether marketing is a necessary evil or the root of all evil, but it’s definitely causing a lot of harm. Let’s see why:


Advertisement: The Biggest Marketing Gimmick
Marketers wield the greatest influence over consumer behaviour. Advertising via the medium of television, newspapers, magazines etc influences our behaviour and buying habits and successfully lures us (as unsuspecting consumers) into buying goods and services, even if there is no need. It creates a sense of dissatisfaction among us with our current possessions so that we will buy new ones.

Television probably wields the greatest influence on us as we watch commercials as vividly as programs. The more TV we watch, the more malls we visit, the more we are likely to spend. It’s nothing but becoming slaves to advertising.

Marketing is doing an excellent job of stimulating our desire to want more convenience and luxuries, and further turning our wants into needs by brainwashing us into thinking that we need a lot more than required; thus, marketing is promoting over-consumption.

Felicity Lawrence in her book Eat Your Heart Out: Why the Food Business is Bad for the Planet and Your Health writes how big companies exploit innocent consumers

“The genius of globalised capitalism is not just to give consumers what they want, but to make them want what it has to sell”.

There’s no dearth of sly companies eager to take advantage of our lack of emotional intelligence and personal finance knowledge. This is another pollution mankind needs to deal with besides environment pollution and climate change.In fact, it seems to be the biggest cause behind every crisis facing mankind, be it the climate crises (the inconvenient truth of global warming and environmental disaster), the health crises, or the financial crises.

Read this interesting post ‘Two Planets’ by Yvette. She writes,

“I doubt reality will ever triumph over profit unless the capitalist system itself is destroyed. This is the only chance of changing our lifestyle”.

Further Joe comments in the same post [Two Planets],

“Capitalism requires a consumer base. It creates an environment where we are bombarded with commercials telling us we need to buy all this crap that we don’t need. Within capitalism corporations do not just fill a need that already exists. In order to maximize profits and be competitive, corporations invent the need (demand for their products) through clever advertisements. The result of this is obviously that we consume far more than we need to”.

To conclude, in my view, although overproduction and overconsumption of goods increases corporate profits along with the increase in a nation’s GDP (growth indicator), it leads to excessive wastage of natural resources (which could be used for other productive purposes) in a resource depleted world, besides environmental pollution and degradation; hence, it is unethical and against the principle of sustainable development.

This so-called economic progress is like taking one-step forward and two-steps back. Perhaps, we need another Mahatma Gandhi to save this Planet Earth from the clutches of greedy corporates and uncaring governments.

What do you think? And if you don’t, please start it now because it affects each one of us and by raising our awareness of these issues, we can make a big difference.

But I know majority of you won’t care because in the words of Upton Sinclair,

“It’s difficult to get a man to understand something when his salary depends upon his not understanding it”.

Also see:

1.10 Reasons Why We Need to Save Money

2. Savings: A Step towards Sustainable Living

3. Is it Complexity or Confusopoly?

4. Why Do We Make Fatal Money Mistakes?

5. Hidden Flaws of Spending: Individual Specific Flaws (#1)

6. Hidden Flaws of Spending: Individual Specific Flaws (#2)

Should You Invest in NCDs?

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Shriram Transport (STCL) NCD issue got oversubscribed many times on day one (July 27, 2009) of the issue. This was the second issue of Non-Convertible Debentures (NCDs) to retail investors by a Non-Banking Finance Company (NBFC). The earlier issue of NCDs by Tata Capital (TCL) in February 2009 had raised 1,500 crore.

Maybe you’re among the lucky few that managed to invest in any of the two NCD issues. Or, it might be possible that you missed both issues and are regretting it now. But don’t worry, there’s going to be many more NCDs issues in the near future. To avoid the last minute rush, it is always better to be properly planned.

This post is going to discuss reasons behind the sudden popularity of NCDs and how to invest in NCDs, should you decide to make them a part of your investment portfolio.

Why there is so much demand for NCDs?
Let’s see the reason for their popularity. At present, Non-convertible debentures (NCDs) are the best debt option to invest in (beyond Section 80C) because of a host of reasons:

1.Better Returns:
Both Tata Capital NCD and Shriram Transport NCD offered interest rates which were quite attractive as compared to interest on other fixed-income options. While yield on redemption of Tata Capital NCD issue was 11.57 –12%, effective yield of Shriram Transport NCD was in the range is in the range of 10.75—11.50% which compares favorably with term deposits (TD) of banks.

If you happen to fall in the highest tax bracket (30.9%), your effective post tax returns will be 7.95 per cent based on rate of interest of 11.50% per annum. And if you’re in the middle tax bracket (20.6%), return after tax will work out to be 9.13 per cent p.a. based on interest rate of 11.50% p.a.

So, right now, NCD seems to be quite attractive investment option among debt instruments given that after-tax returns are around 8% for an investor in the highest tax bracket.

However, in future companies might lower the yield based on the interest rate movement and debt market scenario.


2. No TDS:
Unlike bank FDs or corporate FDs, there is no tax deduction at source (TDS) on NCDs offered in DMAT mode and listed on a stock exchange as per section 193 of the IT Act. 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.


3. Higher Safety:
Unlike corporate FDs which are unsecured, NCD issues by NBFCs are secured debt (NCD’s are 100% secured by assets of the company). Furthermore, both the NCD issues have received good credit rating.

However, this doesn’t guarantee 100% safety. Default risk still remains although very slight. But, default risk remains even in case of Bank FD’s beyond Rs 1lakh.


4. Good Liquidity:
NCDs offer good liquidity due to NSE listing (but listing doesn’t guarantee liquidity). If you would like to go for premature exit, basically you’ve got two options:

a. Sell on the NSE
b. Exercise put option, if available.

However, remember that exiting through secondary market (NSE) entails interest rate risk. If the interest rates fall, the value of NCD will rise (as happened in the case of TATA CAPITAL’s NCDs which were issued in the month of February 2009). And, in an environment of rising interest rates, the value of NCD’s may fall below face value.

But if you plan to hold it till maturity, then there is no-risk due to interest fluctuations.

Furthermore, there is also liquidity risk because, as of now, Indian debt / bond markets are highly illiquid (less frequent trading and insufficient volumes). So, if you plan to encash before maturity by selling on the secondary market (NSE), remember that you might not be able to do so.



How to invest in NCD’s?
If you decide to invest in non-convertible debentures (NCDs), remember the following points:

1.When to Apply:
Apply on the first day of the issue itself because the allotment of NCDs is on first come first serve basis. Chances of issue closing on the first day itself are quite high given the market’s appetite for NCDs.


2. Best NCD Option:
Cumulative option always appear to be most attractive because it offers the highest yield and allows you to reinvest the interest at the same coupon rate / interest rate (i.e., there is no reinvestment risk).

For instance, If you had invested Rs 1 lakh in, say, cumulative option (option 3) of Shriram Transport NCD offering a effective yield of 11.50% p.a. (which was maximum among all the 5 options), you will get pre-tax amount of Rs 1,72,335 at the end of 5 years (assuming Call / Put option shall not be exercised).

On the other hand, if you to would like to receive regular interest income, then you can also look for other NCD options offered such as quarterly, half yearly or annual interest payments, but interest /coupon rate offered is usually lower. And even if the interest / coupon rate is same (e.g. TATA NCD coupon rate was same for annual payment option and cumulative option) you would have to bear re-investment risk, which means that your effective yield can be lower if you’re not able to reinvest your interest income at the same or higher rate of interest (which is highly unlikely).

If you don’t want to lock your money in fixed rate instrument for long term (usually 5 years), you can consider NCD option which is having lower tenure (e.g. 36 months in case of STCL NCD issue), but here the returns are a bit lesser as compared to longest term.

Furthermore, some NCDs also allow staggered redemption; for instance, Shriram Transport NCD Option 1 offering half-yearly interest payment and option 2 offering annual interest payment had provision for staggered redemption (40%, 40%, 20% at the end of 36, 48 and 60 months respectively).


3. Mandatory Requirements:
Before filling the NCDs application forms make sure that you’ve a DMAT account (allotment is compulsorily in dematerialized form) and PAN number (irrespective of amount of application as per SEBI guidelines).


4.Instructions:
Finally, please read instructions carefully because an application form not filled up correctly is liable to be rejected.

Any further question? Please leave it in the comment box.

UPDATE (22 August, 2009): For FAQs regarding taxation of NCDs, comparison with FDs, risks involved in NCDs and stock exchange trading please see part 2: Top 10 FAQs about NCDs.

Also see:
1. Gold ETFs – The best way to invest in Gold
2. ELSS – The best Section 80C Option
3. PPF vs. NSC – How to Decide?
4. How to invest in PPF – 10 Practical Tips

5. Bank Fixed Deposits -Interesting Interest Information

6. NCDs - Top 10 FAQs