EXPLAINATION OF SECTION 185 AND SECTION 186

                                                    FUNDS FOR PRIVATE COMPANY

Apart from Bank Finance, a private limited company depends on internal sources (which are its shareholders, directors and relative of directors) for its investment and fund requirements.

Also, private companies, unlike public companies, are prohibited from accepting deposits from public.

However, the new Companies Act, 2013 has brought a major change in the borrowing provisions and removed the shareholders and relative of directors from the list of eligible lenders.

In brief, 3 categories of loans have been prescribed under the Companies Act, 2013.

 Loans which can be accepted e.g. Loan from Directors, Loan from any other company, banking institutions etc.

Loans which can be accepted subject to complying with Deposit Rules, The Deposit Rules are very complicated, demand a lot of compliance and practically difficult to be followed. If these rules are followed, the company can take loan from shareholders etc.

Loans which can not be accepted eg. Private Company cannot accept loans from any Partnership Firm, HUF etc

Below, the provisions of Act have been stated in a more structured manner.

Please be guided that the complex provisions of law have been simplified for easy understanding of stakeholders.

	Loans from	Conditions, if any:
1.)	Shareholder:	Member: Yes, can accept, but subject to the condition specified in deposit Rules2. Promoters & Their Relative: Yes, can accept if a.)  The condition specified in Deposit Rules2 is met or; b.)  If it is in stipulation of the requirement of any lending Financial Institution (FI) or Bank. This Exemption is available till the loan is not repaid.
2.)	Director	Yes, can accept, but the director will give a Declaration in writing that money is not given out of borrowed funds.
3.)	Employee	Yes, can accept  up to the employee’s annual salary ( there should be a contract of employment with the company) in the nature of non- interest  bearing security deposit.
4.)	Any other Individual	Can’t accept because it is prohibited by the definition of Private Company
5.)	Proprietorship Firm ;	Can’t accept because it is prohibited by the definition of Private Company
6.)	HUF	Can’t accept because it is prohibited by the definition of Private Company
7.)	Partnership Firm	Can’t accept because it is prohibited by the definition of Private Company
8.)	Any Company	Yes, can accept, but also comply with Sec 1863.wherein the conditions are specified for the lender
9.)	Banks	Yes, can accept
10.)	Any other Financial Institution which are not incorporated as Banks ( e.g. Religare, Fullerton, Barclays, Bajaj Finance)	Yes, can accept
11.)	Trust	Yes, can accept, but loan received should be non- interest bearing.
12.)	Outside India	Yes, can accept, but subject to the provisions of the Foreign Exchange Management Act, 1999 and rules and regulations made there under.
13.)	Govt. organization ( e.g. SIDBI)	Yes, can accept

 

Other points:

For Accepting the Loans/Deposits from above parties, a company has to follow the conditions laid down under Sec 180(1)(c) which is 

If Proposed +Existing borrowings (exclude temporary borrowings) > (paid up capital +Free Reserves), the Company shall have to pass Special Resolution in General Meeting.

   2.  Deposit Rules: for acceptance of deposits from shareholders and relative of directors:

Company can accept maximum 25% of (paid up capital + Free reserves) – This limit is for existing and proposed deposits.

Company has to follow the procedure like issuance of circular, depositing insurance, credit rating, appointment of trustee etc.

 

    3. Sec 186: A Company (Private or Public) can’t give loan to any other person or body corporate which is more than

                   60% of its Paid up Capital + Free Reserves + Security Premium

                                                Or

                   100% of Free Reserve + Security Premium

         If this limit is exceeded, prior approval by special resolution in general meeting is required. However, in case a loan or guarantee is given by a company to its wholly owned subsidiary company or a joint venture company than special resolution is not required.

 

Now let us understand the basic of section 185 and 186

Section 185:- This primarily deals with the subject of person to whom company cannot give loan.

Section 186:- This section enlists the exceptions and specifies the limits up to which a company can give loan.

The section 185 of CA, 2013, restrict the company on giving loans, guarantee or provide security to Directors or any other person in whom Director is interested.

The ways via which a director can be interested has been covered via 5 inclusions:-

Point 1 & 2

The inclusion in point 1 and 2 covers the Director and his relatives too.

It Says

1)    Any Director of Lending Company.

2)    Any Relative of Director.

3)    Director of a Company which is its holding company.

4)    Any firm in which such director is partner or relative is a partner.

5)    Any partner of such Director.

Point 3,4 & 5

The inclusion in point 3,4 & 5 only include Director but not his relatives.

It Says

1)    Any PRIVATE Limited company in which such director is a Director or member.

2)    Body corporate in which such Director or Directors hold more than 25% shares.

3)    Body Corporate, MD, BOD or manager accustomed to act in accordance with direction of board or Director of lending company.

A body corporate does not include a co-operative society. But it includes a foreign company.

EXCEPTION TO SECTION 185

1)   W.D./W.T.D.

a)    As a part of service extended to all of its employee.

b)    Any Scheme Approved by members by special resolution.

2)   Given in ordinary Course of Business

How to check ordinary Course:

a)    Is the company engaged in lending activity regularly.

b)    Lend not only to Directors and related parties but also to Arm Length Parties or unrelated parties.

KEY TAKEAWAY:- All N.B.F.C. may not be engaged in lending activities in ordinary course.

NOW LET US UNDERSTAND THE SECTION WITH THE HELP OF PRACTICAL EXAMPLES

EXAMPLE 1

Company A has two Directors Mr. X and Mr. Y. Both holds 50% share each of Company.

Company A wish to give loan to following and have asked for your views on same.

A)   Loan to Director X.

B)   Loan to a relative of Director Y.

C)   Director of company D which is the holding company of A.

D)   A partner of Director of Holding Company.

E)   A partner of Director of company A.

F)   To a firm in which Mr. X is a partner.

G)   To a firm in which relative of Mr. Y is a Partner.

SOLUTION 1

S No	Loan To	Whether Co Can	Reason
1	Loan to Director X.	NO	Included in definition
2	Loan to a relative of Director Y.	NO	Do
3	Director of company D which is the holding company of A.	NO	Do
4	A partner of Director of Holding Company.	YES	A partner of Director of Holding co is not included.
5	A partner of Director of company A.	NO	Included in definition
6	To a firm in which Mr. X is a partner.	NO	Included in definition
7	To a firm in which relative of Mr. Y is a Partner.	NO	Included in definition

  EXAMPLE 2   (PRIVATE LTD CO WITH COMMON DIRECTOR)

Particulars	Company A (Pvt Ltd or Ltd)	Company B (Pvt Ltd)
Directors Cum share holder	A (shareholding 60.0%)B (shareholding 40.0%)	B (Shareholding 75.% )D (Shareholding 25% )
Only Share Holder	Nil	Nil

 A and B are Husband and wife. D is their Son.

Company B wish to avail loan from Company A, Whether Possible?  

SOLUTION 2

Company A cannot give loan to company B as it would be in contravention of Section 185 and would attract penalty.

Planning

1)    Mr B should resign from the post of Director of Company A and gift his shares to Mr A (gift of shares is tax free). They shall appoint another Director in the company.

As B resigns and transfer the shares then the provisions of section 185 wont apply and company A would be able give loan to company B.

OR

2)    Converting Company A into a LLP.

OR

3)    Converting Company B into a Public Limited Company and Mr B reducing his shareholding in Company B to less than 25%.

EXAMPLE 3   (Private Ltd Co To Public Ltd Co)

Particulars	Company A Pvt Ltd or Ltd	Company B (Ltd)
Directors Cum share holder	A (shareholding 60.0%)B (shareholding 20.0%)C (Shareholding 15.0%)	B (Shareholding 10.0% )A (Shareholding 10.0% )C (Shareholding 5.0%)
Only Share Holder	D (Shareholding 15.0%)	Others (75.0%)

  Company B wish to avail loan from Company A, Whether Possible?

SOLUTION 3

No it is not possible to advance loan to company B as Director A, B and C collectively are holding 25% of shares of Company B. And hence get covered under the clause 4 of interested party to Director.

PLANNING

1)    Either Mr A or Mr B or Mr C should resign from the post of Director of Company A. This would bring down the holding of shares to less than 25% and will enable the borrowing between two Companies.

OR

2)    Converting Company A into a LLP.

OR

3)    Either Mr A or Mr B Or Mr C should give up atleast 1% of their share held in Company B to bring down the holding under 25%.

AMOUNT ALREADY EXISTING ON 12^Th SEPTEMBER 2013

Q. In Case any amount is outstanding on 12^th September as a loan to Director or anyone in whom Director is interested.

A. The loan can still continue to appear in the books of accounts of Company; however it can’t be renewed and is to be repaid on the end of the term. If it’s a loan repayable on demand then still it is suggested to make a formal agreement with tenure specified in it.

Q. Company A holds more than 5 % share of company B and have common Director. Company B has availed a loan from bank and because company A holds more than 5% of share of company B it has to be give corporate guarantee for company B to bank.

A. These types of cases are common between related private limited companies. Banks usually takes corporate Guarantee of the companies. In such a case again company cannot renew the Guarantee given to Bank.

However, the CC limits of a company are renewed each year and new Sanction ticket is issued. In such a case corporate Guarantee also gets renewed. It is advised to approach bank and get the clause of Corporate Guarantee removed.  

KEY POINTS

The section is applicable only at the time of granting the loan and  any change in circumstances thereafter will not make the section applicable.

Thus, section 185 will not be attracted in respect of a loan given to an employee, who does not fall within the ambit of specified persons as listed above, but who subsequently becomes a member of the board, because at the time of the loan, no contravention was involved.

KEY POINT IN CONVERSION OF A COMPANY INTO A LLP 

 As per Sec 47(xiiib) of Income tax Act, for tax neutrality of such conversion, turnover of Private Limited Company in any of last 3 years must not exceeds 60 Lakhs. So, if turnover exceeds 60 Lakhs than such conversion will be subject to income tax.

Any capital gain arising in transfer of capital asset would be taxable in hands of company.

Any Gain arising to shareholder on surrendering of shares would be taxable in hands of shareholders.

SECTION 186

Specified transactions are covered under the Section

a)      Loans to any person or other body corporate;

b)      Guarantee or security given in connection with a loan to any other body corporate or person; and

c)     Acquisition by way of subscription, purchase or otherwise, the securities of any other body corporate.

LIMITS UPTO WHICH LOAN CAN BE GIVEN

Higher of

A)   60 % of ( Share Capital + Free Reserves + Security Premium); or

B)   100% of (Free Reserves + Security Premium)

However, if company wishes to invest or give loan to a amount higher than the above then a prior approval of Shareholders is required.

Also shareholders cannot give blanket permission.

KEY POINT

If as on 1.4.2014 the company has given loan or guarantee in Excess of limits specified then it has to file a Special resolution for this by 31^st March 2015.

Q. Whether various Advances would also be considered under this section?

Loan is lending of money with absolute promise to repay whereas advances is to be adjusted against supply of goods and services. Genuine trade advances given to suppliers against orders for supply of goods will not be considered as loans and hence will be out of purview of Section 186. Similarly, advances given to employees against current month’s salary will also not be in the nature of loans.

LOANS AND INVESTMENT BETWEEN HOLDING & SUBSIDIARY COMPANY

Section 185:-Section 185 Exempts loan between Holding Company and Subsidiary Company.

(1)  Any loan made by a holding company to its wholly owned subsidiary company or any guarantee given or security provided by a holding co in respect of any loan made to its wholly owned subsidiary co is exempted from the requirements under this section; and

(2) Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company is exempted from the requirements under this section:

Provided that loans made under sub-rule (1) and (2) are utilized by the subsidiary company for its principle business activities.

SECTION 186:-

Loan or guarantee given and security provided to its wholly owned subsidiary company or a JV, exempted from calculating the limits prescribed under section 186.