Non-Convertible Debentures (NCDs) for Private Companies: Legal Framework, SEBI Rules & TDS Obligations

Non-Convertible Debentures: A Debt Tool for Private Company Capital Raising

Private companies often face a choice: borrow from banks, raise equity from investors, or issue debt securities. Non-Convertible Debentures (NCDs) sit between these options--they're bonds issued by the company that carry a fixed interest rate and repayment obligation, without conversion rights into equity. Understanding the regulatory framework is non-negotiable.

What Are Non-Convertible Debentures?

An NCD is a fixed-income security issued by a company. The debenture holder has a contractual right to periodic interest (coupon) and return of principal at maturity. Unlike convertible debentures, NCDs cannot be converted into equity shares of the company.

For private companies:

• Interest payments are tax-deductible expenses (if debt is used for business purposes).


• Debenture holders are creditors, not equity owners.


• The company gains leverage without dilution.

Section 71 of the Companies Act, 2013: Powers of Private Companies

Section 71 governs the issue of debentures by private companies. Key provisions:

• A private company may issue debentures--both convertible and non-convertible--without following stringent public issue procedures required for listed companies.
• The company must comply with internal governance, including board approval and member consent (if required by the Articles of Association).
• The Prospectus Rules under the Companies Act (which apply to public issues) do not apply to private placement of NCDs by private companies.
• However, private placement must still comply with Section 42 (Private Placement) guidelines--offer to a maximum of 50 persons (excluding employees and accredited investors beyond the 50-person threshold in certain conditions as per recent clarifications).

Private companies issuing NCDs must:

• Pass board resolution approving the terms.


• Ensure Articles of Association permit debenture issuance.


• File the Form of Debenture with the Registrar of Companies (ROC).


• Maintain a register of debenture holders.


• Comply with Section 71(3): the company must create a Debenture Redemption Reserve (DRR) if terms specify repayment beyond 18 months from issuance.

SEBI's OBPP Framework: When Listed NCDs Come Into Play

The SEBI Offer for Sale of Securities by High Net Worth Individuals (OBPP) framework applies when an existing listed or unlisted company's NCDs are offered for secondary sale by HNI shareholders or promoters.

Key points on listed NCDs:

• If a private company's NCDs are not listed on any stock exchange, SEBI's OBPP rules do not apply directly; the transaction is governed by Company law and income-tax law alone.
• However, if a private company intends to issue NCDs with a listing (a rare scenario), it must comply with SEBI Debt Market Development Board (DMDB) guidelines and listing requirements of the exchange.
• For secondary market sales of listed NCDs by HNIs, the SEBI OBPP framework (issued under Rule 5 of Securities Contracts Regulation Rules, 1957) applies--capping transaction size and requiring simplified disclosure.

Most private company NCDs remain unlisted and are governed purely by Company law and income-tax law.

TDS Under Section 193: Interest on Non-Convertible Debentures

This is where many private companies fail--TDS compliance on NCD interest payments.

Section 193 of the Income-tax Act requires deduction of tax at source (TDS) on interest paid on debentures (including NCDs) at the rate of 10% (or 20% if the debenture holder has not furnished a valid PAN, as per Section 206AA).

Critical compliance points:

• Who deducts? The company issuing the NCD (the debtor) must deduct TDS at the time of payment of interest.
• Rate of TDS: Normally 10%. However:

• Payment obligation: TDS must be deposited with the tax authorities within the due date prescribed for that month (usually the 7th of the following month for monthly payments).
• Reporting: The company must issue a TDS certificate (Form 16A) to the debenture holder within the prescribed timelines for credit of TDS in their tax return.
• Common error: Paying interest net of TDS without actually depositing TDS with the government. This attracts penalties and interest under the income-tax law.
• Exemptions: Interest on certain government securities or specified bonds may be exempt from TDS under specific notifications--rare for private company NCDs.

Example: A private company issues NCDs of Rs.10 lakhs at 8% per annum. Annual interest is Rs.80,000. TDS at 10% = Rs.8,000 must be deducted and deposited. The debenture holder receives Rs.72,000, and the company must issue Form 16A for Rs.8,000 TDS.

Practical Compliance Roadmap for Private Companies

• Pre-issuance: Ensure your Articles of Association permit NCD issuance. Draft clear NCD terms (coupon, maturity, call/put options, covenants). Take board approval.
• Filing: File Form with ROC. Register debenture holders. If repayment > 18 months, create DRR.
• Interest payments: Deduct 10% TDS at each interest payment date. Deposit TDS within due date. Issue Form 16A to debenture holders.
• Redemption: Ensure funds are available. File Form with ROC at redemption.
• Audit trail: Maintain records of TDS deposits, challans, and certificates for 6 years.

The Bottom Line

NCDs are a legitimate, cost-effective tool for private companies to raise capital. But Section 71 compliance, proper governance, and TDS discipline under Section 193 are non-negotiable. A single misstep--missing a TDS deposit or failing to file the NCD form--can expose the company to penalties and reputational damage.

I'm CA Harun Raaj, Visakhaputnam. If you're structuring NCDs or need TDS compliance clarity, reach out--let's build a framework that protects your company and your investors.

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