THE COMPANIES ACT 2013: SECTION 185 - LOANS TO DIRECTORS
Updated: May 11
This article will deal with Provisions of section 185 of The Companies Act 2013. Section 185 of CA 2013 deals with Director’s loans. We are going to understand, What is a Director’s Loan? Conditions when Directors opt for ”director’s loan” from their own company. Understanding section 185 of The Companies Act 2013.
What is a director’s loan?
A director’s loan is money you take from your company's accounts that cannot be classed as salary, dividends, or legitimate expenses. Put another way; it is money that you as director borrow from your company and will eventually have to repay.
Another kind of director’s loan is when a director lends money to the company, for example, to help with start-up costs or to see it through cash flow difficulties. As a result, the director becomes one of the company’s creditors.
When and why might one borrow from their company?
Taking out a director’s loan can give you access to more money than you currently receive via salary and dividends. Director’s loans are typically used to cover short-term or one-off expenses, such as unexpected bills. However, they are admin-heavy and come with risks (such as the potential for heavy tax penalties), so they shouldn’t be used routinely but rather kept in reserve as an emergency source of personal funds.
What is the director’s loan account?
The director’s loan account (DLA) is where you keep track of all the money you either borrow from your company or lend to it. If the company borrows more money from its director(s) than it is lending to it, then the account is in credit. However, if the director(s) borrows more, then the DLA is said to be overdrawn.
Be aware that shareholders (and perhaps other creditors) may become concerned if your DLA is overdrawn for any length of time. It would be best if you aimed to ensure that most of the time, it is either in credit or at least at zero. Find an accountant for your small business who can help put together a director’s loan account.
Loans to Directors
When the Companies Act of 1956 was in force, public companies were permitted to grant loans, guarantees, and securities as long as they obtained prior permission from the Central Government. The companies used to exercise a practice of borrowing funds and passing them to subsidiaries and other associate companies through inter-corporate loans. However, when it came to compliance with the loan agreement terms, the holding companies used to take a step back, leaving the subsidiaries in the lurch. To put a stop to the exploitation of the subsidiaries, Section 185 of the Companies Act, 2013 came into force.
Understanding Section 185
Section 185 of the Companies Act, 2013 lays down certain restrictions concerning the granting of loans to Directors to monitor their work.
Before the Amendment
The original Section 185 prohibited the companies from advancing any loan and giving any security or guarantee concerning the loan taken by the company's Directors or any other person in whom the Director was interested. If found guilty of non-compliance, penalties were allowed only to companies or to any recipient to whom such a loan, security, or a guarantee is provided.
After the Amendment
Section 185 (as amended by the Companies (Amendment) Act, 2017):
Limits the prohibition on loans, advances, etc. to Directors of the company or its holding company or any partner of such Director or any partner of such Director or any firm in which such Director or relative is a partner
Allows the company to give a loan or guarantee or provide security in connection with any loan to any person/ entity in whom any of the Directors are interested, 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
The penalty provisions as set out under Section 185 (4) of the Act, in addition to the Company, now extends to an officer in default of the company (which includes any Director, Manager or KMP or any person following whose directions BODs are accustomed to act)
Exemptions With Regard to Loans Given to Directors
Loans to the Managing Director or Whole Time Director: The loans to MD or WTD may be given only if the following conditions are met:- – Where it is part of the Policy of Service of the company to grant loans to all employees. – Pursuant to any scheme which is duly approved by the members by way of a Special Resolution
Loans to Subsidiary Company: Where the holding company grants the loan, guarantee, or security to its wholly-owned subsidiary company, which uses the same for its principal activity of business only
Loans to Companies as part of Ordinary Business: If the rate of interest charged on such loans is not lesser than the rate prescribed by RBI at the time, loans may be given to companies in the ordinary course of business
Loans offered by Banks and Financial Institutions to Subsidiaries: Grant of loan is permitted based on:- – Where the holding company provides the security or guarantee concerning the loan made by the bank or any financial institution to the subsidiary company. – The loan must be utilized for the subsidiary’s principal activity of the business
In any case where Section 185 is not complied with:- – The Lending Company will be punishable with a fine not less than Rs. 5 lac which can be extended to Rs 25 lac (maximum).
– Any officer in default will be punishable with imprisonment for a term which may extend to 6 months or a fine which shall not be less than Rs.5 lac but which may extend to Rs.25 lac.
– The recipient of the loan will be punishable with imprisonment, which may extend to 6 months, or with a fine which shall not be less than Rs.5 lac but which may extend to Rs.25 lac or with both.