Loan to Directors

1. Introduction:

Section 185 of the Companies Act, 2013 (“the Act”) speaks about Direct or Indirect Loan or Advances to Directors by Company. Loan or advances include loan represented by a book debt to any of the directors or giving any guarantee or provide any security in connection with any loan taken by Director or such other person or anyone be it Individual, Firm or Body Corporate in whom the director is interested.

2. To whom the Company cannot give Loan (including book debts) / Guarantee/ or provide Security (“Loan”) in respect of any loan (Directly or Indirectly) as per Section 185(1) of the Act:

• any director of the company;
• any director of the holding company;
• any partner or relative of such director; or
• any firm in which such director or any of his relative is partner.

2.1. Who is relative?

As per Section 2(77) of the Act, following individuals are defined as relative of the director:

• Members of HUF;
• Husband and Wife;
• Person his Father, Mother, Sister, Brother;
• Person & his Spouse with Son & Son’s Wife, Daughter & Daughter’s Husband;

3. Who can obtain Loan:

3.1 Apart from individuals as mentioned under Point 2 above, following individuals/ Firm can obtain loan/ guarantee or received security in respect of loan given from the company:

• Relative of director’s partner;
• Relative of holding company director’s partner;
• Firm in which holding company’s director partner is a partner;

3.2 Section 185(2)- Loan/ Guarantee or provide security to the person in whom director of the company is interested:

The Company may advance Loan/ Guarantee or provide security to any person in whom director of the company is interested subject to the following conditions:

3.2.1 Special resolution is passed at the General Meeting [disclosing full particulars of the Loan/ Guarantee/ Securities to be advanced and the purpose for which it is to be utilized in the explanatory statement to the notice]; and

3.2.2 Loan is utilized for its principal business activities.

Person in whom director of the company is interested:

• Any private company of which any such director is a director or member;
• Any body corporate at a general meeting of which not less than twenty-five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together;
• Any body corporate, the Board of Directors/ MD/ Manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
• How to Calculate Voting Power:

For example: Mr. X holds 50% in A Ltd., which in turn is holding 60% in B Ltd., 20% of C Ltd. is held by B Ltd.

Mr. A’s voting power shall be -

- 50% in A Ltd.;

- 30% in B Ltd. [50% * 60%] and;

- 6% in C Ltd. [50% * 60% * 20%]

Accordingly, A Ltd and B Ltd. shall be the persons in whom director of the company is interested. C Ltd. will not be deemed to be the persons in whom director is interested.

3.3 Section 185(3): Exemptions for grant of loans:

3.3.1 Loan to Managing Director /Whole Time Director: (i) as conditions of service extended to all its employees; (ii) Pursuant to a scheme approved by passing Special Resolution in general meeting of the company.

3.3.2 In Ordinary Course of Business: Companies providing Loan/ Guarantee or provide security in their ordinary course of business for due repayment of loan where interest charged not less than prevailing yield of 1 year, 3 years, 5 years or 10 years, Government security closest to the tenor of the loan.

3.3.3 Any loan to the Wholly Owned Subsidiary: Loan provided by holding to Wholly Own Subsidiary for its principal business activities or guarantee or security provided by holding to its subsidiary for principal business activities.

3.4 Pursuant to MCA circular G.S.R 464(E), dated 5 ^th June, 2015, if private company fulfils following conditions, then provisions of Section 185 of the Act is not applicable to the company:

3.4.1 If No body corporate has invested in the share capital of the company;

3.4.2 Borrowings of such company from bank or financial institution or any other body corporate is less than two times it paid up capital or Rs 50 Crore whichever is less and;

3.4.3 The company did not make any default in repaying the loan.

However, company still have to adhere to Section 186 and could not grant loan or guarantee or provide security exceeding of:

• 60% of its paid-up share capital, free reserves, and securities premium account, or;
• 100% of its free reserves and securities premium account; whichever is more.
• This Section shall not apply to Nidhi companies if the loan given is in the capacity of a member and not in the capacity of a director.
• This Section shall not apply to Government companies, which satisfies following conditions:
• obtains approval from ministry administratively in charge of the company/ State Government before making any Loan/ Guarantee or providing security.
• Which has not defaulted in filing financial statements and annual return with the registrar.
• This Section is not applicable to a company which is in the business of giving loans.

4. Penalty under Section 185:

• For Company- Fine minimum- INR 5 Lakhs and maximum- INR 25 lakhs
• For Defaulted Officer- Imprisonment of 6 months or with fine, minimum-INR 5 Lakhs and maximum INR- 25 Lakhs; and
• For Director or the other person to whom any loan is advanced or guarantee or security is granted- Imprisonment 6 months or with fine minimum-INR 5 Lakhs and maximum INR- 25 Lakhs, or with both.

4. Can a director give loan to the Company:

A director is permitted to give loan to the company. However, he has to give an undertaking that the loan given is out of his personal funds and not from the funds of the company. Director can give loan to the company and there is no prohibition for it.

5. Which loans and advances shall be considered as deemed dividend?

5.1 when a company in which the public are not substantially interested extends a loan or an advance to:

5.1.1 any of its shareholders who has more than 10% voting power in the company or;

5.1.2 to any concern in which such shareholder is substantially interested or;

5.1.3 for the individual benefit of such shareholder or;

5.1.4 on behalf of such shareholder to the extent the company has accumulated profits,

Such above mentioned payments would be deemed as a dividend under Section 2(22)(e) of the IT Act.

5.2 Exception to the Deemed Dividend:

Following payments will not be treated as deemed dividend:

5.2.1 Loan given by a company involved in money lending, where loans have been extended in the ordinary course of business.

5.2.2 Loan extended to shareholders, subsequently adjusted against dividend declared and distributed later.

5.2.3 If advance or loan is given to a concern then shareholder (beneficial owner) of lender company must have at least 10% voting power in the lender company and a substantial interest in the borrower company at the time of advancement of loan.

In case of CIT vs. Jignesh P. Shah (Bombay High Court):

Section 2(22)(e) of IT Act has to be construed strictly. If assessee is not a shareholder of lending co, section 2(22)(e) does not apply even if funds are ultimately paid by company in which assessee is a shareholder.

5.2.4 Section 2(22)(e) does not apply to commercial transactions [CBDT Circular No. 19/2017 dated 12 June 2017]

5.2.5 Amount received for providing corporate guarantee shall not be called as deemed dividend u/s 2(22)(e). [DCIT vs. Accel Limited - [2020] 118 taxmann.com 103 (Madras)].

5.2.6 Section 2(22)(e) will not apply to an advance or loan made to a shareholder or a concern (in which shareholder has substantial interest) by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company. [ PCIT vs. Mohan Bhagwat Prasad Agrawal - [2020] 115 taxmann.com 69 (Gujarat)]

6. Whether company can give interest free loan to its director?

In case company falls under provisions of section 185(2) and 185(3) then only it can give loan to its Director. However, said loan may be considered as deemed income in the hands of the director as prescribed above under section 2(22)(e) of IT Act. As far as interest free loan is concerned, provisions of Section 186(7) shall also become applicable as follows:

As per section 186(7) of the companies Act, 2013, loan cannot be given at the interest rate which is below than prevailing yield of one year, three-year, five year or ten-year Government Security closest to the tenor of the loan.

However, provisions of Section 186 (except Sub-Section 1) are not applicable in the following cases:

6.1 Where any loan, guarantee has been given or any security provided or investment made in the ordinary course of its business by - (i) A banking company, or (ii) An insurance company, or (iii) A housing finance company (iv) A company engaged in the business of financing of companies or of providing infrastructural facilities;

6.2 To any acquisition made: (i) by a non-banking financial company registered under Chapter IIIB of the Reserve Bank of India Act, 1934 and whose principal business is acquisition of securities, provided that exemption to non-banking financial company shall be in respect of its investment and lending activities (ii) made by a company whose principal business is the acquisition of securities (iii) of shares allotted in pursuance of clause (a) of sub-section (1) of section 62.

6.3 Holding company can give loan/ investment/ guarantee/ providing security to its wholly own subsidiary, without passing special resolution in case of loan limits exceeds 60% of its Paid-up Share Capital, Free reserves and Securities Premium Account or 100% of its Free reserves and Securities Premium Account, whichever is more.

Therefore, company cannot give interest free loan to its director and in case of default in section 186, following penalty shall be levied on the company and its directors/ officers:

• Company: Minimum fine of INR 25,000/- and Maximum fine of INR 5,00,000/-
• Officers of the Company: Maximum Imprisonment of 2 years & minimum fine of INR 25,000/- and maximum fine of INR 1,00,000/-