When operating a partnership or sole proprietorship, partners and owners take money out of the company as needed to cover their daily personal expenses. The same beliefs that most people have about the business are that they can take money out of it whenever they need to. That isn’t the case, though. The Company Act 2013 governs all business dealings with the company’s directors.

This article explains when and where the directors and their related entities are allowed to take loan from the companies, Although the Company Act 2013 explicitly prohibits directors from receiving direct loans, it does permit directors to receive loans in certain circumstances.

General Prohibition on Loans and Advances by Companies under Section 185

• According to section 185 of the Companies Act of 2013, The company cannot lend any money, represented by a book debt or give guarantee or security in connection with the loan to the following:

• Its director; or

• A holding company director; or

• Any partner or relatives of that director; or

• Any firm where such a director or relative is a partner

Exemption to Private Company

Section 185 will not apply to Private companies:-

1.  In whose share capital,no body corporate has invested any money (i.e. No Body corporate is the shareholders of the company); and

 2.  If the borrowings from any Banks, Financial Institutions or body corporate is less than twice of its Paid up share capital or 50 Crore, whichever is lower; and

 3.  Such company has not defaulted in repayments of such borrowings subsisting at the time of making transactions; and

 4. Such company has not defaulted in filing its financial statements required under section 137 or annual return required under 92 with the registrar.

Acceptability of a loan from a company to the director in certain situations

The Companies Act does not outright forbid loan grants. The Companies Act has made the following loan scenarios permissible:

1. The restrictions outlined in Section 185 do not apply to any loans made to managing directors or full-time directors as part of the terms of service the company offers to all of its workers.

• A company may advance loans including any loan represented by a book debt or give guarantee or provide security in connection with any loan taken to any person in whom any of the directors of the company is interested provided
  • Special Resolution is passed in the general meeting
  • The company is engaged in the business of granting of loan
  • Explanatory Statement to the Notice is attached

The company can advance the loans or give the guarantee, or security only to these persons

• any private business where any of these directors serves as a member or director;
• any corporate entity wherein any director, or two or more directors combined, own or control at least 25% of the voting power; or
• any corporate body that is customarily disposed to act in compliance with the directives or instructions of the Board, or of any director or directors, of the lending company, including the managing director, the board of directors, or the manager.

• Let’s examine the parties in the following examples that a company director is interested in.

• Any private company in which one of these directors serves as a member or director.
• In addition to being a director of B Ltd, Mr. Abhishek is a director of X Ltd.
• In this instance, X Ltd. is regarded as an entity that Mr. Abhishek is interested in. As a result, loans from B Limited to X Limited are allowed, and vice versa.

• Any corporate entity in which one or more directors possess a minimum of 25% of the voting power:

• Mr. Raj owns 55% of the shares of A Ltd., he also holds 70% of Y Ltd. and 15% of Z Ltd.
• As a result, Mr. Raj will have 55% of the voting power in A Ltd., 70% in Y Ltd., and 15%% in Z Ltd.
• As a result, A Ltd. and Y Ltd. fall under the group of companies  which have common director

• Loans from a company that is in the loan and guarantee business:

• The aforementioned prohibition does not apply to a business that lends money or offers guarantees or securities for loan repayment in the regular course of its operations.

• As long as the interest rate on the loan is set at a minimum equal to the current yield on government securities with terms of one, three, five, or ten years that are closest to the loan’s tenor;

Approvals for loans exceeding threshold mentioned in Section 186 of Company Act 2013

Loans that surpass the designated threshold amount

• When the total of the loan, investment, guarantee, or security that has already been made along with the loan, investment, guarantee, or security that is proposed to be made exceeds a certain threshold, the company offering the loan, guarantee, or security in connection with that loan must get the approval of its shareholders through a special resolution.

• 60% of free reserves, paid-up capital, and securities premium, or
• 100% of the securities premium or free reserves, whichever is greater.

Rate of Interest on loan given to parties in which companies director is interested in

A loan may be given at a concessional rate or interest-free, even though the Companies Act of 2013 does not specify an interest rate for businesses other than those whose primary activity is money lending.

How the Income-tax Act treats loans to directors

• A private company that lends money to one of its directors may be subject to the deemed dividend provisions of section 2(22)(e) of the Income Tax Act of 1961.

• Once the requirements of section 2(22)(e) are met and it is established that the dividend is deemed to have been paid by a private company, the individual is required to pay tax at the rate of 30% on the deemed dividend.

• Section 2(22)(e) of that Act states that any loans or advances made to any of the following individuals by a private company, to the extent that the company has accumulated profit, will be considered dividends:

• A shareholder who possesses at least 10% of the voting rights and is the beneficial owner of the shares (not eligible for a set dividend rate). For the purposes of this discussion, a director of a private company is someone who owns at least 10% of the voting rights as a shareholder.

• any issue in which the company’s shareholder has a significant stake as a member or partner.

• For the benefit of each of these shareholders individually, or as directed by law.

As a result, before taking out a loan from a private company, a director should conduct research because the majority of the loan amount will be subject to income tax once it is considered a dividend. In such circumstances, one may also consider other options, such as obtaining loans from banks or other financial institutions in India.

Penalty

Section 185(4) of the Act lays down penalty if the provisions mentioned above relating to providing loans are contravened. If the company advances loan in contravention to Section 185,

• The company shall be punishable with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh.
• The director or any other person related to the director, to whom any loan is advanced or guarantee or security is given shall be liable to be punished with imprisonment which may extend to six months or with fine which shall not be less than Rs.5 lakh but which may extend to Rs.25 lakh or with both.

Final Thoughts

A director is required to disclose to a company any interest it may have in a deal or arrangement, as well as any shares it may hold in other businesses. As a result, the company and any other businesses where the director holds directorships must be informed of any loans taken out by the director or by anyone else in whom the director has an interest.

In the register of loans, investments, etc., each company keeps track of its loans and investments.

It is also feasible for what we are talking about to be reversed. That is, since it is not expressly forbidden by company law, a director may also grant loan to a company. It is important to remember that money used by directors to provide loans should be their own personal funds and should not be a part of any company’s cycle of financial mismanagement.