Section 185 of the Companies Act, 2013 prohibits the Company to extend loans directly / indirectly to Directors or any other person in whom the Director is interested, or providing any guarantee/security in connection with any loan taken by such Director/ Person

Who is the ‘Any other person in whom director is interested’?

1. any Director of the lending company/holding company/ any partner or relative of any such director;
2. any firm in which any such director/relative is a partner;
3. any Private Company of which any such director is a director/member;
4. any Body corporate at a general meeting of which not less than 25% of the total voting power may be exercised/controlled by any such director/ by 2 or more such directors, together;
5. Any Body Corporate, BOD/MD/Manager, thereof is accustomed act in accordance with the directions/ instructions of the Board/ of Directors of the lending company.

Under what conditions can a Company give loans?

There are 5 exceptions under which a Company can extend loans directly / indirectly to Directors

• Loan to MD/WTD as part of the conditions of service extended by the company to all its Employees.
• Loan to MD/WTD pursuant to any scheme approved by shareholders by Special Resolution.
• Loan by a company in Ordinary Course of its Business of providing loans/guarantees/securities for due repayment of any loan provided that loan carries interest at not less than the Bank Rate declared by RBI.
• A loan made by a holding company to its subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly-owned subsidiary company; or
• 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.

Non Applicability of this Section on Private Companies

This section shall not apply to Private Companies provided they fulfil the following 3 conditions:

1. in whose share capital no other body corporate has invested any money;
2. if the borrowings of such a company from banks or financial institutions or any Body corporate is less than twice of its paid-up share capital or fifty crore rupees, whichever is lower; and
3. Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this section.

Deemed Dividend under Section 2(22)(e) of the Income Tax Act, 1961

The provision of Deemed Dividend will be applicable in cases wherein the Director of the Company to whom the loan is extended is also a shareholder in the Company.

According to Section 2(22)(e), when a company in which the public are not substantially interested*, extends a loan or an advance to:

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

then such payment would be deemed as a dividend under Section 2(22)

*a company in which the public is not substantially interested is otherwise called a closely held company

Related Party Disclosures

In cases where a loan is extended or a guarantee or security is provided to a Director or any other person in whom the Director is interested, under Section 185, then such transaction shall be disclosed in the financial statements of the Company under Related Party Disclosures.

Non Applicability of Section 185 on Nidhi Companies

Section 185 shall not apply, provided the loan is given to a director or his relative in their capacity as members and such transaction is disclosed in the annual accounts by a note.

Non Applicability of Section 185 on Government Companies

Section 185 shall not apply to Government Company in case such company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before making any loan or giving any guarantee or providing any security under the section.

Penalties in case Section 185 is contravened

• Company to be punishable with a fine of minimum 5 lacs and maximum 25 lacs
• Director/ Any other Person to whom loan advanced or guarantee/security is given/provided to be punishable with imprisonment up to 6 months or fine of minimum 5 Lacs and maximum 25 lacs or both.