Non-Convertible Debentures (NCDs) are fixed income options and a great alternative to company fixed deposits (FDs) as they also lock your money for a fixed term and will deliver returns at a pre-specified rate. Since these cannot be converted into equity, investors enjoy higher returns and the ability to trade them in the stock exchange.

Income from investing in NCDs

NCDs are issued in the open market for a specified period where interested investors can buy them. These can also be purchased at stock markets.

They come in two form, secured and unsecured. An secured NCD will mean that the money is being raised against company assets and the dues can be paid off by selling those assets.

The interest on the NCDs will depend on its rating. When it has a higher rating, (which means the lower the possibility that the issuing company will default on payments) the interest offered will usually be lower. Generally the interest rates are higher than those offered on fixed deposits. They could range between 9 to 11 percent.

Apart from the interest, the other way to make a profit off NCDs are to sell them in the stock markets. The profits made from this are known as returns.

What are tax implications on income from NCDs?

As mentioned before, there are two types of income from NCDs:

1. Interest

Interest earned on a NCD will be treated as "interest income" that is, its treatment is exactly like any interest income from other fixed income instruments like FD. These will be taxed at the same rate as any interest income and under the section 'Income from other sources' in the income tax returns (ITR) form.

The difference here is that there is no TDS (tax deducted at source) on registered NCDs held in demat form. Additionally, TDS will be if the annual interest paid exceeds Rs 5,000 whereas in case of FDs, interest earned beyond the exempted limit (Rs 40,000 for FY20) will be subject to TDS before being credited to you.

Tax is charged at 10 percent in both the cases.

2. Capital gains

If the investor decides to sell the NCDs on the stock exchange before the NCD matures, there is a possibility of capital gains that can arise from such a sale. Any profit or loss made on NCDs sold within a period of 12 months from the date of allotment are treated as short term capital gains / loss (STCG/L) and on those sold after a period of 12 months, the resulting gain or loss will be called long term capital gains / loss (LTCG/L).

All STCG sale of NCDs are taxed at normal rates according to the taxpayer income tax slab, this is because the income made will be added to their income tax return.

As for long term capital gains on listed securities, these are taxed at the rate of 10 percent without indexation or 20 percent with indexation, whichever is lower. However, bonds and debentures do not come with the indexation benefits, which means LTCG from NCDs are taxed at 10 percent. Also, it is subject to education cess at the rate of 4 percent (FY20).