Home Companies Act Section 185 & 186 of Companies Act r.w Section 2(22)(e) of Income Tax – Consequences of Non- Compliance
Section 185 & 186 of Companies Act r.w Section 2(22)(e) of Income Tax – Consequences of Non- Compliance

Section 185 & 186 of Companies Act r.w Section 2(22)(e) of Income Tax – Consequences of Non- Compliance


Section 185 of Companies Act

The provisions of Section 185 of the Companies Act reconsigning certain restrictions with regard to the granting of loans to the director for keeping track of their working. The following were laid down by this section 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 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 subjected to:

  1. Passing of Special Resolution by the company in a General Meeting (Approval of at least 75% of the members is required),
  2. Utilization of loans by 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:

  1. Where it is part of the Policy of Service of the company to grant loans to all employees.
  2. Pursuant to any scheme which is duly approved by the members bypassing of a Special Resolution.

– Loans which are given to the subsidiary  shall be 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 be again an exception if the rate of interest charged on such loans is not lower when compared with the rate which are specified by RBI at the time, loans may be given to companies during the ordinary course of business.
– Loans which are given by Banks and Financial Institutions to Subsidiaries shall be permitted based on the following:

  1. 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.
  2. The loan must be utilized for the subsidiary’s principal activity of the business.

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.
– While in case of an officer in default shall be punishable with imprisonment for a term of 6 months or a fine 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 a fine minimum of INR 5 Lakhs to a maximum of INR 25 Lakhs or both.

Section 186 of Companies Act

Provisions of the Section 186 of Companies Act is dealing with the loans and investments which are made by the company.
The word Investments here as per the section means or can be said to be including the following:
– Subscription or purchase of shares
– Subscription of 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 loan to a person or a body corporate (any)
– provide a security (any) or provide a guarantee with respect to a loan offered to any other person or body corporate
– and purchase, subscribe, or otherwise 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 Government Company

A Government Company which is involved in defense production shall not comply with section 186 of the Companies Act.
And in case of a government company, but excluding a listed company, it should obtain approval of the Ministry or Department of Central Government which is administratively in charge of the company or the relevant State Government, as the case may be.

In case of Acquisition of Shares

As per the provisions of Section 186, we could day that acquisition of shares allotted in pursuance of right 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 Loans, Guarantee or Security

The applicability of section 186 is not required in case of loans, guarantees, or security made:
– In the ordinary course conducting business by a banking company;
– In the ordinary course of its business by an insurance company;
– In the ordinary course of its business by 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 NBFC (Non-Banking Financial Institution), shall be with respect to investment and lending activities majorly.

Penalty for Contravention

The punishment in case of any committing of 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 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 Income Tax Act, when a company in which the public are not substantially interested or a closely held company, extends a loan or advance to:

  1. any of its shareholders who has more than 10% voting power in the company; or
  2. to any concern or entity in which such shareholder is substantially interested; or
  3. for the shareholder and his individual benefit; or
  4. on behalf of such shareholder to the extent there is accumulated profits with the company;

then it should be understood that such payment would be deemed as a dividend under Section 2(22) of the Companies Act.


Exceptions to this would include the following:

  1. Loan given by a company involved in money lending, where loans have been extended in the ordinary course of business, and
  2. Loan which are offered to shareholders, subsequently adjusted against the dividend declared and also distributed later to these shareholders itself.




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