What is a Debenture?

A debenture is a certificate issued by a company. It is therefore an unsecured debt tool that is issued by a company to acknowledge that it owes money to the debenture holder. It is usually issued to the public with the help of a prospectus which is quite similar to the issue of shares.

As no collateral is involved in the case of debentures, their holders are dependent heavily on the reputation and creditworthiness of the issuer. The primary motive for issuing debentures is to raise funding or capital for businesses.

For investors, debentures are considered to be low-risk investment options that help to generate palpable returns. A debenture can be considered an unsecured debt unit. It is a certificate issued by a company where it states that it owes a certain amount of money to the debenture holder. These certificates are given to the public by a prospectus. No collateral is included in the case of debentures and the holders of the debentures are therefore dependent only on the reputation of the organization that issues the debenture. Debentures are primarily meant to get funding or the capital required for business-related reasons. Investors consider debentures as a low-risk investment that can bring them substantial returns too.

Debenture interest is the money the owner of the debenture earns after they invest money through the debenture of the company. It should be noted that when the company wants collateral as security then the owners of debentures would not get any interest on the amount they have invested. It would be paid at a rate that is fixed on face value. Interest on debentures must be paid whatever the status of revenue. The Income Tax Act of 1961 states that TDS (Tax Deducted at Source) must be applied at a rate of interest specified.

In simple terms, interest is an award where investors in debentures receive interest for investing in the company. The company must pay the interest accrued at regular intervals. The amount of interest is pre-set and the interest rate is calculated at the face value.

What is Interest on Debentures?

Debentures are one of the easiest ways to generate business funding or capital. The companies usually generate debenture funds by issuing certificates that mention the rate of interest that would be paid to the debenture holders. This rate is known as interest on debentures.

As seen above, debentures are collateral-free investments. So, the investors in the debenture instrument have to rely on the reputation of the company.

The interest that would be paid to investors after a certain period is usually mentioned in the debenture certificate. This certificate also includes the terms that contain other details of the business association between debenture-holders and the company. Therefore, the terms of use of the debentures are pre-set and the investors don’t have to rely upon anything else to get interested in their investment in the company.

Types of Debenture

The Companies Act of 2013 prohibits companies to issue debentures that have voting rights. So, the companies can issue the following types of debentures –

Security-based

• Secured debentures
• Unsecured debentures

Convertibility-based

• Convertible debentures
• Non-convertible debentures

Priority-based

• First mortgage debentures
• Second mortgage debentures

Negotiability-based

• Bearer debentures
• Registered debentures

Permanence-based

• Redeemable debentures
• Irredeemable or perpetual debentures

Accounting Treatment for Interest on Debentures

The below-mentioned journal entries are documented in the books of an enterprise in association with the interest on debentures:

When interest is due and tax is deducted at source

• Interest on Debentures A/c Dr.
• To Debentureholders’ A/c Cr.
• To TDS Payable A/c Cr.

(Amount of interest due on debenture and tax deducted at source)

For payment of interest to debenture holders

• Debenture holders A/c Dr.
• To Bank A/c Cr.

(Amount of interest paid to debenture holders)

On transfer debenture Interest Account to the statement of Profit and Loss

• Statement of Profit and Loss Dr.
• To Interest on Debentures A/c Cr.

(Debenture interest transferred to profit and loss A/c)

On payment of tax deducted at source to the Government

• TDS Payable A/c Dr.
• To Bank A/c Cr.

(Payment of tax deducted at source on interest on debentures)

What is Interest in Reserved Debenture?

The capital that holders of debentures might obtain by investing their funds in the debentures of a specific company is known as debenture interest. However, when a company inclines to issue debentures as collateral security, the debenture holders doesn’t receive any interest on their investment.

Debenture interest is often regularly paid by the corporation at a fixed rate on its face value. Notably, regardless of the firm’s income position, this interest must be paid to the holders of the debentures and is charged to the corporation that issued the debentures.

According to the Income Tax Act of 1961, corporations that issue debentures are required to withhold taxes (TDS) at a specific rate of interest. However, this tax is only levied when the amount of payable interest exceeds a specific threshold. The debenture issuing corporations deposit the tax obtained in this way with the income tax authorities.

Important Notes on Interest on Debentures

• Interest on debenture is a charge that has to be paid irrespective of whether the enterprise has acquired any profit.
• According to the Income Tax Act of 1961, a company must deduct income tax at the recommended rate from the interest payable on debentures when the payable value of the interest amount surpasses the guided limit. It is known as TDS.
• Tax Deducted at Source is to be collected and deposited with the tax authorities. The debenture holders can allocate this deducted amount of tax against the total tax that is due from them.

Conclusion

Debentures are a good way to collect funds for businesses. However, the businesses must be sure that they won’t suffer from a loss in their businesses in order to issue the debentures with confidence. For investors, it is the reputation and goodwill of the company that acts as collateral. Having no collateral attached to the investment process means that there is more risk of returns in comparison to earnings in shares of a company.

Therefore, debentures often have lower rates of interest. However, being an easy way to collect funds, companies often resort to debentures to start their businesses with debenture funds. When managed carefully, debentures can be a great way to fund businesses.

FAQs

Q1. Will the debenture holders get any interest payment if the company issues debentures as collateral security?

Ans. No. Debenture interest is the capital that debenture holders can earn for investing their money in a given company’s debenture. However, when a company tends to issue debentures as collateral security, the debenture holders would not receive any interest on their investment.

Q2. What is meant by Tax Deduction at Source (TDS)?

Ans. According to the Income Tax Act, of 1961, a company must deduct income tax at the recommended rate from the interest payable on debentures when the payable value of the interest amount surpasses the guided limit. It is known as TDS.

Q3. What are the two types of debentures based on security?

Ans. Debentures based on Security are –

• Secured debentures
• Unsecured debentures