Bonds and Debentures are types of debt instruments that can be issued by a company. In India, the two terms are used interchangeable, but in USA they refer to two separate kinds of debt securities.
In case of bonds, an investor loans money to an institution like government or corporate. Bond acts as a written promise to repay the loan on a specific maturity date. Normally, bonds also include periodic interest (Coupon) payments over the bond's duration, which means that the repayment of Principle and Interest/Coupon occur separately. Coupon is generally paid semi-annually or annually. Bond purchases are generally considered safe, and highly rated corporate or government bonds come with low default risk.
Bonds are SLR (Statutory liquidity ratio) and non-SLR bonds. SLR bonds are those bonds which are approved securities by RBI which fall under the SLR limits of banks.
Bonds provide the borrower with external funds to finance long-term investments, or in the case of government bonds, to finance current expenditure. Bonds and Stocks are both securities, but the difference between the two is that (capital) stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely.
Sovereign bonds are issued by the government of India, or by Reserve Bank of India. These can be referred to as low-risk or even risk-free bonds.
Corporate bonds are issued by the companies and offer interest rates higher than bonds issued by public sector units and other financial institutions. The interest rate on these bonds is governed by their credit rating; higher the rating, lower is the interest rate offered by them.
Deep discount (zero-coupon) bonds are the ones where there is no interest or coupon payment and the interest amount is factored in the maturity value itself.
They are issued by Government backed entities and interests earned from these bonds are tax exempted. The Central Government has authorized to issue tax-free, secured, redeemable, non-convertible bonds. Some of the public undertakings which raise funds through issue of tax free bonds are NHAI, REC, IRFC, PFC, HUDCO, NTPC etc.
The section 54EC of the Income-tax Act, 1961 allows a deduction in respect of long term capital gains arising from sell/transfer of any long term capital asset (for example, any immovable property, jewelry or shares) which was held for a period exceeding three years. In case of shares, the holding period should be 1 year.
The Investment in these Bonds is to be made within six months from the date of such transfer of capital assets (Land/House Property etc.) for being exempted from Capital Gains Tax under Section 54EC of the Income Tax Act, 1961.
Since the investment into 54EC bond is locked for 3 years, you cannot sell or transfer the bonds. If you do so, the amount of capital gains which were given as exemption will consider being taxable long term capital gains in the same financial year in which the sell/transfer took place.
Debentures have a more specific purpose than bonds. Both can be used to raise capital, but debentures are typically issued to raise short-term capital for upcoming expenses or to pay for expansions. Debentures are never asset-backed (they are not secured by any collateral) and are only backed by the credit of the issuer.
Some debentures and bonds are convertible, which means that they can be converted into company stock. In a sense, all debentures are bonds, but not all bonds are debentures. Whenever a bond is unsecured, it can be referred to as a debenture.
The debentures which can't be converted into shares or equities are called non-convertible debentures (or NCDs). NCDs are used as tools to raise long-term funds by companies through a public issue.
Besides, NCDs offer various other benefits to the owner such as high liquidity through stock market listing, tax exemptions at source and safety since they can be issued by companies which have a good credit rating as specified in the norms laid down by RBI for the issue of NCDs.
NCD in India more or less work like company fixed deposit, where you are lending a company to get some interest income and your money back after few years.
There are two types of NCDs-secured and unsecured. A secured NCD is backed by the assets of the company and if it fails to pay-back principle or interest, the investor can claim it through liquidation of these assets. Contrary to this, there is no backing in unsecured NCDs if company defaults.
Any company seeking to raise money through NCD has to get its issue rated by agencies such as CRISIL, ICRA, CARE and Fitch. A higher ratings (e.g. CRISIL AAA) means the issuer has the ability to service its debt on time and carries lower default risk.
Capital Gains: NCDs get listed on stock exchanges where investors can sell it before maturity. Any gain earned through selling in secondary market is termed as capital gains. What gains an investor will make depends on the interest rate scenario. If interest rates are higher than offered by NCD, then the returns will be lower if sold through secondary markets and there might be negative return for investors in some cases. However, if there is fall in interest rates after buying NCD, then selling on stock market may prove beneficial as the NCD will demand a premium.
Tax: The interest earned on NCD is clubbed with income of the bond holder and is taxed at individual marginal income tax rate. The capital gains have different taxability. Short -term capital gains which arise by selling NCD before one year, is taxed as per the income slab of individual holding the instrument. Any gains which arises by selling NCD after one year and before maturity is taxable as long term capital gains. The applicable tax rate is 10.30% without indexation, since cost indexation benefit is not available in case of bonds and debentures.