Synopsis: Are Corporate Fixed Deposit (FDs) better than Bank FDs? The article covers the definition of Corporate FDs, how it works, its features, risk factors, tax implications and things to consider before investing in a Corporate FD.
Fixed deposit has been a favourite investment instrument for investors in India. They offer a guaranteed and predictable return on investment. There are, however, other types of bank FD which you can consider. The interest rates of Corporate FD are higher than that of the bank FDs. Corporate FDs may be a lucrative investment option for corporate investors aiming to improve their income. They also come with certain risks and considerations for investors to consider before making an investment.
What is a Corporate FD?
A Corporate Fixed Deposit (Corporate FD) is a fixed-income investment instrument provided by a company and Non-Banking Financial Companies (NBFCs) to collect funds from the masses. Like a fixed deposit, a person puts in a certain sum for a certain fixed period of time and receives interest at a fixed rate. Corporate FDs pay out higher interest rates than conventional bank fixed deposits. Duration may be from a few months to several years depending on the scheme and the issuer. Unlike bank deposits, such deposits are not issued by a bank and are not necessarily as safe as a bank’s deposits, depending on the company’s financial strength and creditworthiness.
Example: If a person invests ₹1 lakh in Corporate FD with an interest rate of 8% per annum for 3 years, he will get the return on the invested amount on the agreed interest rate and the amount used by the company for business activities.
The major benefits of the Corporate Fixed Deposits
- Higher Interest Rates: One of the main reasons why you choose to go for a Corporate FD is that it offers a comparatively higher interest rate. Bank FDs can provide a 6%-8% interest rate while Corporate FDs can provide a rate that is one or three percentage points higher, depending on the duration and the issuer.
- Flexible Tenure Options: Corporate FDs come in a variety of tenures and are generally offered with a term of from one year to five years or even longer. In this manner, investors can choose a time frame that corresponds to their speculation goals as well as liquidity needs.
- Multiple Interest Payout Options: investors can choose to get the interest income in several different ways. The majority of Corporate FDs offer monthly, quarterly, half yearly, annual and cumulative payout options, catering to the income takers and long investors.
- Fixed and predictable returns: The interest rate is fixed at the time of investment, which gives investors a good idea of the interest they will earn on their investments over the duration of the deposit. This is a foreseeable investment alternative as compared with the market linked alternatives.
- Low Minimum Investment Requirement: A few Corporate FDs are available for investors who are planning on making small investments.
- Premature Withdrawal Facility: In some cases the Corporate FDs give the option to investors to take out their investment prior to maturity. However, the penalty, lower interest rates or lock-in period may be applicable on the withdrawals as per the terms mentioned in the withdrawal process.
- Loan Against Deposit: Some firms give investors the option to take a loan against their Corporate FD and thereby get liquidity without breaking up their investment in advance of the tenure.
Corporate FD vs Bank FD
While the working of Corporate FDs and Bank FDs is similar, there are some differences that investors need to understand before deciding between the two.
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Disadvantages of Corporate FDs
- Credit risk: risk of failure in the payment of the debt by the FD issuing company. If there are financial problems or bankruptcy, the investors have the possibility to lose all of their own capital or the interest that they had earned.
- No Deposit Insurance: The Corporate FDs are not insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) as the fixed deposits are insured by the Corporation in banks. This means that if the issuing entity defaults on payment, investors would not be able to count on any government guarantee of payments.
- Liquidity Risk: Corporate FDs are typically intended for holding up until the maturity date. Some issuers might offer the ability to early redeem the funds, but may impose penalties, lock-in periods or restrictions that make it challenging to access the funds when needed.
- Inflation Risk: Corporate FDs are low risk but are fixed return, so over the time it can get eroded because of inflation. The interest earned may not maintain the purchasing power as inflation rises appreciably.
- Reinvestment Risk: If the Corporate FD is maturing, the investors may face the risk of not investing the amount of the FD at the same interest rate at the time of maturity. This is especially important in the midst of a declining interest rate.
- Interest Rate Risk: In case the market interest rates increase after a investor invests in a Corporate FD, he or she will continue to get the lower one agreed at the time of investment. Thus, it is possible that newer deposits will have greater returns than the older ones.
These risks do not deter investors from taking a look at the Corporate FD, but they are important to consider before going ahead with a decision.
Credit Ratings in Corporate FDs
The credit ratings are important for evaluating the safety of Corporate FDs due to the fact that such funds are not insured by deposit insurance. Financial strength and the ability to pay back debt is the basis for assigning ratings to a company by agencies like CRISIL, ICRA, CARE Ratings and India Ratings. AAA – Risk Free and Safest grade of security, AA – High level of safety, A – Adequate safety, but a relatively higher risk, BBB – There is a high risk of default. Lower rated Corporate FDs can be more lucrative but it is important to take safety precautions and opt for the issuers with a good credit rating if they are available.
Taxation of Corporate FDs
The interest income on corporate FDs would be taxable in the category “Income from Other Sources.” Unlike some investments where deduction on investment amount is given, there is no deduction given on investment amount in case of Corporate FDs. Interest income would be included in the investor’s total annual income and taxed as per the income tax slab rate.
Example: If an investor is in the 30% tax bracket, then the interest on the Corporate FD will be taxed at 30% (plus cess and surcharge). If the interest paid to an investor is more than the prescribed limit during that financial year, then the company can also deduct the Tax Deducted at Source (TDS). Thus, investors should pay attention to the after-tax return on investment instead of the actual interest rate offered as it might affect the returns on the investment made in a Corporate FD after taxation.
Conclusion
Fixed income investors can get higher returns on corporate FDs compared to traditional bank fixed deposits. But investors should take the time to review the credit ratings and associated risks of the issuer prior to investing. A solid balance of return and safety can be achieved by selecting highly rated, financially sound issuers.
Written by Boyapati Sai Jasmitha
