I wrote Introduction to NCDs – Part 1 some time ago, and in that post I covered basic aspects about them. Then I wrote about how you could buy NCDs or bonds, and in this post I am going to look at some other questions that have cropped up about them since that time.
In a subsequent post I will address some more questions about listing, and yields etc. but this post will address some points which are slightly less complex than those ones.
How are NCDs taxed?
NCDs can earn you income in two ways – you can buy the series which promise an interest payment periodically, or you can buy the series that doesn’t pay you any interest but pays you a higher lump – sum amount at maturity.
Both these types are taxable.
If you buy a NCD that pays interest then the interest will not attract TDS, however you will have to add the interest to your other income and pay tax on it according to your income tax slab.
If you buy a NCD that pays a higher amount on maturity then that will attract capital gains tax, and you will have to pay capital gains tax on the money when you eventually receive it.
Are all NCDs allotted first – come first serve and why does this make a difference?
The listing gains game has started on NCDs the way it started on IPOs a few years ago, and as a result retail investors have found that they aren’t able to get full allocation on the NCDs that they apply for.
Every company that has come out in the recent past has allotted bonds on the first come first serve basis, and I think that will continue to happen in the future as well.
What this means is that if you plan to buy a NCD then you must do it on the first day itself. That will ensure that you get as much allotment as possible, and your money isn’t stuck with them for long for no reason.
Where can I get real time over subscription numbers of NCDs?
Since over subscription is happening right now, and it makes a difference on when you apply – it would be nice to be able to see how much a NCD is oversubscribed at any point of time.
However, currently, this data is not shown anywhere publicly. Even though these bonds list on NSE and BSE, they don’t display the over subscription numbers on those websites.
I think the first come first serve basis allotment, and the over subscription data not being displayed anywhere situation will change with time, but so far that hasn’t happened.
How do I judge the relative attractiveness of two or more different NCDs?
There is a lot of subjective judgment involved when it comes to this question. You can straight away compare the rate of interest between two NCDs, but it is rather difficult to compare the quality of issuers especially when both of them are lesser known.
Considering whether the issue is secured or unsecured is one parameter that you can use. The additional debt that the current issue will add to the books is another issue that you can consider.
The business of the company is another thing of course. Who does it lend to, what collateral it takes, and how good is the mix on its loan book.
But perhaps the most important thing to consider is how much additional interest this NCD is giving over other prominent NCDs like the SBI one.
If that is just a percentage point or so then there is a good chance that may mean that this NCD trades at a discount when the interest rates rise in the future.
All these factors may sounds like a bit too complicated to figure out, but NCDs are reasonably popular these days, and most news articles do cover all this information in some detail. If you read a three or four articles about an issue you will gain a good bit of knowledge about these factors.
Also, the credit rating of an issue tells you what the issuer think about them, and they have a brief summary on their rationale that you can read as well.
To summarize this post – NCDs are taxable – no matter what option you choose, so far they are allotted first come first serve, and that makes a difference because the current issues are being over subscribed. If you decide to invest, then do so at an early stage.
This is counter to applying for share IPOs because they don’t use the first come first serve method and also show the over subscription online.
And finally, judging the relative attractiveness of two issues is subjective but factors such as credit ratings, issue size, loan book mix etc. can help you in judging that.
26 thoughts on “Introduction to NCDs – Part II”
hi i have a doubt recently i purchased NCDs in physical form and i want to convert the same into my demat a/c is it possible…
and also pls let me know which is the better option?
buying in physical form or in materialised form..
Hi, thanks for the reply.
do you mean if debenture is allotted on 1 oct 2011 and first intrest comes on 1 Oct 2012, then do I need to incude the full amount in income of year ending on 31.3.2013 or should I calculate and include some portion for year ending on 31.3.12(6 months) and rest to be for the year 31.3.13
Dear Manshu, suppose an NCD is allotted on 1 Oct and intrest is paid annually on 1 oct too. Then how do we calculate the taxable component as financial year ends on 31 March ?
When you get the money is the date that’s important.
Let us assume, it more like FD, you will get money by maturity. Why people sell it for discount price ? Due to availability of better interest( like closing and opening FD). How it depends on issuer quality ? Because of risk, the chance of getting money back makes the price volalite ?
Why someone sells will depend from one person to another. Some people buy these bonds with the intention of selling at a profit, and don’t intend to hold it till maturity at all, so when their bond trades at a discount, they will sell it.
Then there will be other investors who think they can deploy their money in better yielding assets even after taking the small loss, so they will then sell it.
So, these are the two primary reasons.
The price depends on issuer quality because someone like SBI is perceived to be much more reliable in interest payment than a Manappuram, so that’s why people will pay a little extra to hold SBI bonds when compared with Manappuram. Perceived safety.
Probably you can put more light to one more thing. Say for example: IndiaInfoline NCD had face value of Rs 1000 and when it got listed it was available at discount. Say at Rs 900. If someone buys the NCD at Rs 900 will he earn 11% or whatever interest they are paying on Rs 1000 or Rs 900 ?
Request you to kindly reply….
Interest or coupon rate is always on face/par value of the security and has nothing to do with quoted/traded price on the bourses.
Having said that, if an NCD has a coupon rate of 11%, whatever will be the market price, be it quoting at discount or premium, will pay same interest on face value (Rs 1000 in this case) only. Hope, it clears the smog..
Thanks for answering that Avi.
can NCDs be transferred from one demat a/c to another?
The NCDs can be transferred (or transmitted) freely in accordance with
the applicable provisions of the Act. The normal procedure followed for transfer of securities held in dematerialised form shall be followed for transfer of the NCDs held in electronic (demat) form. The seller should give delivery instructions (DIS) containing details of the buyerâ€™s DP account to his depository participant.
In case the transferee does not have a Demat account, the seller can re-materialise (demat to physical form) the NCDs and thereby convert his/her dematerialised holding into physical holding. Thereafter the NCDs can be transferred in the manner as stated above. In case the buyer of the NCDs in physical form wants to hold the NCDs in dematerialised form, he can choose to dematerialise the securities through his DP. hope, this will make understanding clear.
hi manshu, dont you think there is complete lack of transparency in the debt markets on information such as subscription (%), allotment status. Applicants in NCDs are in the black about everything. As you also mentioned.
Yes, I agree to that – but frankly it doesn’t surprise me. Last year when infrastructure bonds were launched, a lot of info about them wasn’t clear as well.
I remember a lot of issues were supposed to be only Demat at first which means they don’t attract TDS, but then later on they said that they will be paper only – now as far as tax is concerned what does that mean?
Does the entire issue attract TDS or do only those people have to pay TDS who hold it in paper form or what?
And I’m sure you know how the NPS implementation is going on and all the problems folks are facing there.
I’m sure things will improve given more time and as the market becomes deeper, but as it stands today there is a lot to be desired.
please clarify on capital gains on higher amount on maturity.
Are you referring to gains due to cumulative interest option (and not regular interest option)?
Capital gains could also be due to gains received while selling through exchange.
Avi – I meant gains due to the cumulative interest option. Another reader has pointed out that it is incorrect, and that it will be treated as interest. Were you saying the same thing?
I think, Cumulative interest on any debt instrument i.e. FD’s, bonds, NCD is taxable in the period to wihch it accrues to. eg 5 year Cumulative FD/Bond, tax is payable every year on int income. However, when interest rate is not explicit, and the bond/debenture is redeemable on premium (like manappuram 400 day ncd), then it attracts CG tax upon redemption. Hope I am right!!
So like interest is taxed in the case of Recurring Deposits – in the same manner?
I meant a zero coupon debenture (redeemable on premium) attracts tax upon maturity. Ya
Okay, so now I’m confused, from your earlier comment I thought you were saying that the bond holder will have to pay tax on interest every year even when they are not paid interest every year.
But from this one, it appears to me that you are saying that the bond holder will pay tax only at the final year of maturity?
That tax will be calculated as interest income and not capital gains as I wrote earlier.
Am I understanding you correctly?
The difference is clearly the one between cumulative interest (interest reinvestment) and redemption premium, the two are separate concepts. From my understanding, when a coupon rate is explicitly assigned to an instrument (9%, 10%) then int on it is taxable even though its cumulative in nature. Eg i recently invested in STFL’s subordinate debt (private placement) which is 11.3% -Cumulative, tax is payable every year, tds deducted). However, when no coupon rate is assigned (0%), eg manappuram 400 day issue, no tax is payable during tenure of bonds, only CG tax payable upon maturity (redeemable at premium, which is different from interest)
Hmmm, interesting, I wasn’t making that distinction at all, and I have certainly not read anything anywhere that suggests this either. I’m trying to remember if the other cumulative NCDs had a coupon assigned but can’t recall it right now, and haven’t come across this distinction any other place as well.
Thanks for bringing it up, and I’ll create a new post for this topic alone.
in case I read it right.. tds is not to be deducted if debentures are in demat form. pl correct if I am not right.
Two conditions, both of which should be satisfied:
They should be compulsorily on a Demat form.
They should be listed on a stock exchange.
good that you raised it. redemption premium is different from interest income and to be treated as capital gains post 365 days.
yes Manshu. I meant the same. capital gains can not be due to interest income.. rather it will be on the premium (more than face value) it will be commanding (and sold, of course) through exchange (due to interest rates scenario).