Introduction of Debentures and Interest on Debentures
Debentures are a type of debt instrument issued by a company or a government to raise capital or funds for its business. It is an acknowledgement given by them for having borrowed a certain amount of money, which it promises to repay at a future date.
The debenture is issued under the company’s seal. It is in the form of a certificate, which is an acknowledgement of indebtedness. It usually specifies a particular period or date for repayment. The debenture contains a contract for repayment of the principal after a fixed period and for payment of interest on debentures at a fixed rate. Also, it generally creates a charge on the undertaking of the company or some parts of its property. Some debentures can be converted to equity shares, while others cannot be.
Issue of Debentures
In general terms, the definition of the word issue is to supply or distribute. But in this context, the meaning of the word ‘issue’ is to give out a certificate with the company’s seal as an acknowledgement of the debt taken by the company. The procedure for issue of debentures by a company is very much like the issue of shares. Another word for issuing can be supplied or giving out something, which may be banknotes or company shares.
Interest on Debentures
In general terms, the definition of the word issue is to supply or distribute. But in this context issuing debentures means to give out a certificate with the company’s seal as an acknowledgement of the debt taken by the company. The procedure for the issue of debentures by a company is very much like the issue of shares. Another word for issuing can be supplied or giving out something, which may be banknotes or company shares.
Terms of Issue
Companies use debentures when they need money for their expansion. The terms of issue of debentures come with a promise to repay at a future date. Debentures are a part of the borrowed capital. Therefore debenture holders are called creditors of the company. At the time of liquidation and repayment, first preferences are given to the denture holders.
There are four different types of debentures. They are (1) Secured and Unsecured (2) Registered and Bearer and (3) Convertible and Non-Convertible. (4) First and Second.
Secured Debentures: These are the debentures where a charge has been established on the properties or assets of the company for the purpose of repayment of the debt.
Unsecured Debentures: These debentures do not have a particular charge on the assets of the company. However, a floating charge may be established by default.
Registered Debentures: These debentures have details of names, addresses, and particulars of holdings of the debenture holders. The said details are filed in a register kept by the company. These debentures can be moved only by a normal transfer deed.
Bearer Debentures: These debentures can be transferred by way of delivery. The company does not have any record of the debenture holders
Convertible Debentures: These debentures are chargeable to equity shares or in any other security either at the choice of the company or of its holder. These debentures are either fully or partly convertible.
Non-Convertible Debentures: These cannot be changed into shares or any other security.
First Debenture: This type is repaid before the other debentures.
Second Debenture: This can be paid only after the First debenture is paid back.
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Ethical Words and Definitions
Words related to ethics or the words associated with ethics in this context would be individualism, value-system, principle etc. There are both advantages and disadvantages in investing in debentures issued by the companies.
Few terms of ethics in business are Honesty, Integrity, Promise-Keeping & Trustworthiness, Loyalty, Law Abiding, etc.
Advantages
If the investor needs fixed income at a lesser risk, they prefer this.
Financing through them is less costly, compared to the cost of preference or equity capital.
The company does not involve its profits in a debenture.
A debenture does not carry voting rights. Financing through them does not dilute the control of equity shareholders on management.
Disadvantages
Every company has a certain borrowing capacity. With the issue of debentures, the capacity of the company to further borrow funds reduces.
Debentures put a burden on the company on its earnings. So there is a greater risk when the earnings of the company fluctuate.
The company has to make provisions for repayment on the specified date, even during the period of financial strain on the company.
FAQs on Issue and Redemption of Debentures
1. What is Meant by the Issue of Debentures and When is It done?
Ans: When a company has some financial crisis, they need to raise funds that are unsecured by collateral. The crisis here is the word meaning problem. The other terms for ‘problem’ are complications, disagreement, etc. They usually have a repayment term of more than 10 years. This is issued purely by the creditworthiness and goodwill of the issuer for support. When the company faces a problem or meets an unfavourable situation and it is badly in need to be dealt with and overcome, they make use of the debentures to raise capital. The government quite often issue such debentures to raise funds. The issue of debentures is decided after holding a board meeting with the board of directors and shareholders.
2. Is there a Tax on Debenture Interest in Balance Sheet?
Since debenture is a medium or long term debt instrument used by companies to borrow money, a fixed rate on interest has to be paid to the one who purchases the bond. As the company pays interest on debentures, the interest earned out of debentures is taxable under the Income Tax Act. It is taxed under the head ‘Income from other Sources’ with regular slab rates. Any other reasonable expenditure like commission or remuneration incurred for the same can be claimed as a deduction.
