by Interest on debentures refers to the fixed amount of money that a company agrees to pay periodically to its debenture holders for the funds borrowed. It is usually paid semi-annually or annually and is calculated as a percentage of the face value of the debentures. The rate of interest is pre-fixed at the time of issuing the debentures and is stated in the debenture certificate. The interest paid is a financial charge and must be paid even if the company is incurring losses.
Features of Interest on Debentures:
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Fixed Rate: The interest is paid at a fixed rate mentioned in the terms of the debenture issue.
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Charge on Profit: Interest on debentures is a charge against profits and must be paid regardless of the company’s profitability.
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Tax Deductible: Interest paid on debentures is allowed as a tax-deductible expense under the Income Tax Act.
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Priority over Dividends: Interest is paid before any dividends are declared to shareholders.
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Creditor Relationship: Debenture holders are creditors, not owners, so they only receive interest, not a share of profits.
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Obligation: Failure to pay interest can lead to legal action or impact the company’s creditworthiness.
Types of Interest Payments:
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Gross Interest: This is the total amount of interest before deducting tax (TDS).
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Net Interest: This is the amount paid to debenture holders after deducting tax at source.
TDS (Tax Deducted at Source) on Debenture Interest:
As per the Income Tax Act, companies are required to deduct tax at source (TDS) before paying interest on debentures if the interest amount exceeds a specified limit (₹5,000 for listed companies and ₹2,500 for others). The TDS rate is generally 10%, but it may vary as per applicable tax laws.
Interest on Debentures Issued at Discount or Premium:
When debentures are issued at discount, the interest is calculated on the face value, not on the amount received.
Example:
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Debentures of ₹10,00,000 issued at 95% (₹9,50,000 received)
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Interest @10% is calculated on ₹10,00,000 = ₹1,00,000
Accrued Interest on Debentures
If debentures are purchased between interest dates, the buyer compensates the seller for the accrued interest from the last interest date till the date of purchase. This accrued interest is a capital cost for the buyer and is not treated as income in the hands of the seller.
Importance of Interest on Debentures:
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Predictable Expense: It allows companies to plan their cash flows effectively.
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Investor Confidence: Regular interest payments increase investor confidence and goodwill.
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Tax Shield: Being a tax-deductible expense, it helps reduce the company’s taxable income.
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Obligation Fulfillment: It reflects a company’s credibility and financial discipline in the market.
Accounting Treatment of Interest on Debentures:
| Transaction | Debit (Dr) | Credit (Cr) | Explanation |
|---|---|---|---|
|
Interest Due (Accrued Interest) |
Interest on Debentures A/c (Expense) | Debenture Interest Payable A/c (Liability) |
Interest expense is recognized as it accrues, even if not yet paid. |
|
Payment of Interest |
Debenture Interest Payable A/c (Liability) | Bank/Cash A/c (Asset) |
Actual payment of the accrued interest reduces liability and cash. |
|
Tax Deducted at Source (TDS) (if applicable) |
Debenture Interest Payable A/c | TDS Payable A/c (Liability) |
TDS is deducted and withheld for tax authorities. |
|
Transfer to P&L (Year-End) |
Profit & Loss A/c (Expense) | Interest on Debentures A/c |
Interest expense is closed to P&L to determine net profit. |
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