When is a director’s loan allowed?
A director’s loan runs in two directions, and the Act treats them differently. Money a director lends to the company can be taken if it is that director’s own money. Money the company lends to its director is barred, except in the cases section 185 lists.
When can a director lend to the company?
The company may borrow from a director. The sum is not treated as a public deposit if the director declares in writing that it is not given out of funds borrowed or accepted from others. A relative of a director has that same route only in a private company. The board approves the borrowing under section 179. If the company’s total borrowings would exceed its paid-up share capital, free reserves, and securities premium, section 180 also needs a special resolution of the shareholders.
The sum is a borrowing in the accounts. The director is a related party, so the loan is disclosed in the financial statements. Form AOC-2 is the extra disclosure where section 188 requires it, which is where the arrangement is not in the ordinary course or is not at arm’s length. Interest, if any, is whatever the parties agree, including none. Interest that is paid is deducted under section 194A when the threshold applies, and it is income of the director. A loan from a non-resident director also has to satisfy FEMA. It is not documented as a resident director’s loan.
When can the company lend to a director?
Section 185 says the company shall not, directly or indirectly, advance a loan, including a book debt, or give a guarantee or provide security for a loan taken by a director of the company or of its holding company, by a partner or relative of such a director, or by a firm in which such a director or relative is a partner.
A loan to any other body corporate in which a director is interested can be given only if the shareholders pass a special resolution that states the particulars, and the borrower uses the money for its principal business activities. Section 186 is a further ceiling on loans, guarantees, and investments generally: 60 percent of paid-up share capital, free reserves, and securities premium, or 100 percent of free reserves and securities premium, whichever is higher, unless a special resolution approves more. Interest on a section 186 loan is not below the yield on a government security of a matching tenor.
Which loans does section 185 allow?
| Case | What the section allows |
|---|---|
| Managing or whole-time director | A loan as part of conditions of service extended to all employees, or under a scheme approved by a special resolution |
| A company in the business of lending | A loan in the ordinary course, at not less than the yield on a government security of a matching tenor |
| Wholly owned subsidiary | A loan from the holding company, or a guarantee or security for a bank or institution loan, used for the subsidiary’s principal business |
| Any subsidiary | A guarantee or security by the holding company for a loan a bank or financial institution gives the subsidiary, used for its principal business |
An LLP is not in this section. Whether an LLP may lend to a partner is on the LLP loan page.
What is the penalty?
The company is punishable with a fine of not less than ₹5 lakh and not more than ₹25 lakh. Every officer in default is punishable with imprisonment up to six months or a fine of not less than ₹5 lakh and not more than ₹25 lakh, or both. The director or the other person to whom the loan, guarantee, or security is given faces the same imprisonment or fine, or both.
Frequently asked questions
Four questions cover a deposit, interest, a partner’s firm, and an LLP.
Is a director’s own money a deposit?
Not when the director gives a written declaration that the money was not borrowed from someone else. Without that declaration, the deposit rules can apply.
Can the loan to the company be interest-free?
Yes. The Act does not set an interest rate for a loan from a director to the company. If interest is paid, tax is deducted under section 194A once the threshold for that payer is crossed.
Can a company lend to a director’s firm?
No. Section 185 bars a loan, or a guarantee for a loan, to a firm in which such a director or that director’s relative is a partner.
Does section 185 apply to an LLP?
No. Section 185 is a Companies Act rule. An LLP’s loan to a partner is on the LLP loan page, and the LLP Act sets no rupee cap.
Sources
A loan from a director is excluded from deposits by the Companies (Acceptance of Deposits) Rules, 2014, when the declaration is given. A loan to a director is section 185. A loan to any other person is also tested under section 186.