The provisions of Section 185 of the Companies Act rescind certain restrictions regarding the granting of loans to directors for keeping track of their work. This section lays down the following in accordance with the amendment made by the Companies (Amendment) Act, 2017:
– It limits the prohibitions which are placed on the granting of loans and advances to Directors of the company or its holding company, or any person who is a partner of such Director, or any firm or entity in which such Director or relative is a partner
– It also allows the company to give any loan or guarantee or security in connection with any loan provided to any person or entity in whom any of the directors are interested, but shall be subject to:
- Passing of Special Resolution by the company in a General Meeting (Approval of at least 75% of the members is required),
- Utilization of loans by the borrowing company shall be solely for its principal business activities.
– And the penalty provisions as set out under Section 185(4) of the Companies Act, in addition to the company, now extend to an officer in default of the company (which would include any Director, Manager or KMP or any person in line with whose directions BODs [Board of Directors] of the company are accustomed to act).
Exemptions with respect to Loans given to Directors
– Loans which are given to WTD (Whole Time Director) or MD (Managing Director) should meet the following conditions:
- Where it is part of the company’s policy to grant loans to all employees.
- Pursuant to any scheme which is duly approved by the members, bypassing a Special Resolution.
– Loans which are given to the subsidiary hall are the exception where the holding company grants the loan, guarantee, or security to its wholly-owned subsidiary company, which uses the amount for its principal activity of business only.
Loans to Companies that are provided as part of the ordinary business shall again be an exception if the rate of interest charged on such loans is not lower than the rate specified by the RBI at the time. Loans may be given to companies during the ordinary course of business.
– Loans which Banks and Financial Institutions give to Subsidiaries shall be permitted based on the following:
- Where the holding company provides the security or guarantee with respect to the loan made by the bank or any financial institution to the subsidiary company.
- The loan must be used for the subsidiary’s principal business activity.
Penalty Provisions
– In case of non-compliance with section 185, the lending company shall be punishable with a fine which shall not be less than INR 5 Lakhs and can be extended to INR 25 Lakhs.
– In the case of an officer in default, shall be punishable with imprisonment for a term of 6 months or a fine of a minimum of INR 5 Lakhs and a maximum of INR 25 Lakhs.
– And the recipient of the loan shall be punishable with imprisonment which may extend to 6 months or an amount of a minimum of INR 5 Lakhs to a maximum of INR 25 Lakhs or both.
Section 186 of the Companies Act
Provisions of Section 186 of the Companies Act deal with loans and investments made by the company.
The word Investments here, as per the section,n, means or can be said to be including the following:
– Subscription or purchase of shares
– Subscription for the purchase of share warrants
– Subscription or purchase of debentures, bonds, or such other similar debt securities.
And the following shall not be included in the meaning or definition of investments, namely:
– Making of loans and advances
– Such other financial transactions, including the lease, purchase of receivables, or other credit facilities.
The provisions of Section 186 also state further that a company cannot directly or indirectly:
– give a loan to a person or a body corporate (any)
– provide security (any) or provide a guarantee with respect to a loan offered to any other person or body corporate
– and purchase, subscribe to, or otherwise acquire the securities of any other body corporate
– which, when computed, exceeds 60% of the paid-up share capital, free reserves, and the securities premium account, or 100% of its free reserves and securities premium account, whichever is more.
Non-Applicability of Section 186
In case of a Government Company
A Government Company that is involved in defense production shall not comply with section 186 of the Companies Act.
And in the case of a government company, excluding a listed company, it should obtain approval from the Ministry or Department of the Central Government with which it is administratively in charge of the company or the relevant State Government, as the case may be.
In case of the Acquisition of Shares
As per the provisions of Section 186, we can say that the acquisition of shares allotted in pursuance of rights shares shall not be applicable.
And any acquisition made by a company whose principal business is the acquisition of securities, i.e., an investment company, shall also not be applicable with the same.
In case of Loansguarantee, securities
The applicability of section 186 is not required in case of loans, guarantees, or security made:
– In the ordinary course of conducting business by a banking company;
– In the ordinary course of its business, by an insurance company;
– In the ordinary course of its business, it is a housing finance company;
– By a company that is engaged in the business of financing companies or in the business of providing infrastructural facilities.
In case of the acquisition, which is of Shares and Loan
In the case of an acquisition made by a non-banking financial company whose principal business is the acquisition of securities, this shall not be applicable.
The exemption allowed to NBFCs (Non-Banking Financial Institutions) shall be primarily with respect to investment and lending activities.
Penalty for Contravention
The punishment in case of any contravention of section 186 would be:
– The company shall be levied with a fine of a minimum of INR 25,000 to a maximum of INR 5,00,000.
– For any official in default, maximum imprisonment of 2 years and a fine shall be a minimum of INR 25,000 and a maximum of INR 1,00,000.
Section 2(22)(e) of Income Tax Act
According to provisions of section 2(22)(e) of the Income Tax Act, when a company in which the public is not substantially interested or a closely held company extends a loan or advance to:
- Any of its shareholders who have more than 10% voting power in the company; or
- To any concern or entity in which such shareholder is substantially interested; orForr the shareholder and hisinterestt; or onn behalf of such shareholder to the extent there are accumulated profits with the compan.Then, it should be understood that such payment would be deemed as a dividend under Section 2(22) of the Companies Act.
Exceptions
Exceptions to this would include the following:
- A loan given by a company involved in money lending, where loans have been extended in the ordinary course of business, and
- Loans that are offered to shareholders are subsequently adjusted against the dividend declared and are also distributed later to these shareholders themselves.
