Company fixed deposits are similar to bank fixed deposits where you deposit a sum of money for a fixed period of time and earn a defined rate of interest. Fixed deposits are a very popular instrument of savings in India with over 20 percent of all household opting for this process. Bank interest rates are regulated by the Reserve Bank of India guidelines and rarely differ more than 0.5 percent between banks. Interest rates on company fixed deposits are often significantly better than bank deposit rates.
Things to know about company fixed deposits
1. Companies that accept fixed deposits
By company law, manufacturing companies are permitted to accept fixed deposits from the public up to the limit of 25 percent of their paid up capital and free reserves. In the last 10 years or so, most large blue chip companies have discontinued accepting fixed deposits as they found that administrative cost of handling thousands of small depositors outweighs the advantage.
Companies in the non-banking financial services sector are the most active in the company fixed deposits arena. They are permitted to accept fixed deposits up to 1.5 times the net funds deployed in their business. Examples of such companies include the housing finance companies like HDFC and LIC Housing Finance and Shriram Transport Finance. The interest rates offered by these companies are typically 1 to 1.5 percent higher than bank fixed deposits and these organizations have a good track record of on-time payment of interest and return of principal.
2. Smaller companies may offer higher interest rates but have higher risk
A very large number of smaller companies accept fixed deposits but with a very mixed report card on the safety of deposits. One study says that the estimated value of company deposit defaults since the 2008 financial crisis is over Rs 10 billion. One Delhi based investor association has filed complaints against more than 3500 companies in National Capital Region(NCR).
As a thumb-rule, any company that offers an interest rate, that is better than bank interest by 3 percent or higher, needs a studied and close examination. Such high interest rate indicates the company’s inability to borrow money from banks. The scrutiny should include through checking to find out if the company deposits have a credit rating from CRISIL or other reputed rating agency, the company financial reports over at least 3 years to see if it is a healthy company, the background of its promoters and so on. Most of these data may not be readily available in its authentic form.
3. Don’t go only by what your broker says
A major mistake small investors often commits is by depending way too much according to what their brokers or commission agents suggest. Most of these intermediaries get a larger commission from the more troubled companies and recommend these to investors. The broker cannot help you recover money from the company even in the event of a default.
4. Company fixed deposits are not be as liquid as bank deposits
The small investors should always be prepared to face any emergency where he may need to encash the fixed deposit. With bank deposits, the process is well laid out with the penalty being only a reduced interest rate. With company deposits, the company may decline premature termination. Even if they accept premature termination, you could be made to wait several days.
5. Withholding taxes
With company fixed deposits, if the interest earned is over Rs 5000 per year, a ten percent withholding tax would apply. This tax would be deducted even if your total income is below taxable limits. For bank deposits, on the other hand, you could fill in a declaration form and avoid the tax deduction.
You can also breakup the fixed deposit investment between multiple companies, each earning below the tax threshold. This would add to the paperwork that you need to keep track of.
6. Examine other options for better interest rates
Most banks offer one percent higher rate for deposits for senior citizens. You can examine if opening a bank deposit jointly with a family member over the age of 60 can give you an interest rate similar to what you would get from a company deposit.
The Fixed Maturity Period (FMP) schemes offered by several major mutual funds are also an alternative to company fixed deposits. FMP funds are invested in company deposits and in government securities. There is the element of risk that FMPs do not commit to a rate of return but only offer an indicative rate. On the other hand, the interest earned is tax free.
Do’s and Don’ts of investing in company deposits
It is important to remember that fixed deposits, whether in a bank or a company, are for moderate rate of return with safety of principal. If your risk appetite is greater, you should explore other investment options such as equity in operating companies or for an even greater risk-reward, the option of investing in start-up companies.
If a company offers any interest rate that is higher than bank interest rate by 3 percent or more, you should start with the assumption that your money could be at risk. Be especially careful of colleagues or acquaintances who claims to have successfully invested in these companies because they could have been part of so-called Ponzi scheme. In this fraudulent scheme, each participant is asked to induce five others to invest money. From these new inflows, the first participant is paid off and each new participant is required to introduce five new members. This process continues until the whole pyramid collapses.
Thumb rule to decide on a good company fixed deposit
Government backed companies like HDFC and LIC Housing Finance provide a very high degree of safety with interest rates better than bank fixed deposits. An alternative, as noted earlier, is to invest in the FMP schemes of major mutual funds.
You also need to clearly define in your own mind the objective for investing in a fixed deposit. If it is all about parking funds for a period of time to be withdrawn for a specific event, make sure that funds will be available when needed. Even very large companies could have periods of financial stress and they might delay repayment of fixed deposits. If it is to grow the capital, safety of principal should always be the overriding factor.