Pradeep. K MittalPast Central Council of

The Institute of Company Secretaries of India, New Delhi

Corporate Lawyer & Advocate

Delhi High Court, Delhi9811044365/9911044365

SECTION 185 – ITS SWEEP AND AMBIT

BY

In this Article, an attempt has been the amplify the scope and meaning of Section 185 and other applicable provisions of Companies Act, 2013 (hereinafter referred to as Act) and rules made there under.

1.1 Section 185(1) provides that save as otherwise provided in the Companies Act, 2013, no Company directly or indirectly shall:-

(a) advance any loan; or(b) any loan represented by a book

debt; or(c ) give any guarantee; or(d) provide any security in connection

with any loan taken by any director of the company or such other person in whom the director is interested.

2. The Section 185(1) undoubtedly restrict giving of loan and other facilities to a Director of the company and further says “to any other person in whom the director is interested”. The Explanation to Section 185(1) further explain the meaning of expression “to any other person in whom director is interested” means: -

(a) any director of the lending

company, or(b) director of a company which is its

holding company; or© any relative or partner of any such

director; or(d) any firm in which any such

director or his relative of such director is a partner; or

(e) any private company of which any such director is a director or member;

(f) any body corporate at a general meeting of which not less than 25% of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or

(g) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or if any director or directors, of the lending company.

APPLICABILITY

3. The Section 185 is applicable to both public as well as private companies unlike Section 295 of Companies Act, 1956 which exempted private companies. At the same time, the provisions of Section 185 also applies to the loans, etc. given by a company either ‘directly or indirectly’ as was provided under the old provision of Section 295 of Companies Act, 1956.

Now, we will have to understand the meaning of “direct or indirect” loan in the light of various judicial pronouncements. The “indirect loans” will connote that the company shall not give loan through the mode of one or more intermediaries. However, the word ‘indirectly’ cannot be read as converting what is not a loan into a loan. Hence, the amount given must be strictly a loan and a debt, which is not in the nature of loan, cannot be said to be the case of an indirect loan.

WHAT IS MEANT BY “LOAN”

4. In view of the importance and significance of this topic, it is absolutely necessary to understand the precise and concise meaning of word “loan” – in view of the serious implications in the event of violation of the provisions of the Act. The Section 2 of Companies Act, 2013, does not define “loan”. A loan is defined by the Oxford English Dictionary as " a thing lent; something the use of which is allowed for a time, on the understanding that it shall be returned or an equivalent given, a sum of money lent on these conditions and usually with interest."

4.1 The Hon’ble Supreme Court in the case of Shree Ram Mills Ltd Vs. Commissioner of Excess Profit Tax, MANU/SC/0054/1954 = AIR 1953 SC 485 has defined the word “Loan” in the following words:-

At bottom this is a question of fact. Of course, money so, left could, by a proper agreement between the parties, be converted into a loan, but in the absence of an agreement mere inaction on the part of the managing agents cannot convert the money due to them, and not withdrawn, into a loan. A loan imports a positive act of lending coupled with an acceptance by the other side of the money as a loan.

The relationship of borrower and lender cannot ordinarily come about by mere inaction. The clause in the Articles of Agreement quoted above was relied on for the purpose of showing that there was such an agreement in the case. We are unable to construe the provisions in that way. They merely give the managing agents a right to receive their commission at a certain time. If the money is not paid in time it lies with the assessee as a debt due to the agents.

4.2: The Calcutta High Court in the case of Saradindu Sekhar Banerjee Vs. Lalit Mohan MANU/WB/0045/1941 = AIR 1941 Cal. 538

It is contended on behalf of the appellant that the appellant is entitled to the benefit of the Bengal Money-lenders Act, 1940. That Act deals with money-lending and money-lenders. Leaving the purchase money unpaid is leaving a debt unpaid. Every loan is a debt but every debt is not a loan. The purchase money due to the plaintiff is a debt due to the plaintiff but is not a loan or a transaction which is in substance a loan.

4.3: The Division Bench of Allahabad High Court in the case of M/s Laxmi & Co. Vs. Commissioner Of Income Tax MANU/UP/0063/1960=AIR 1960 ALL. 278

The actual nature of the transaction was the supply of goods on credit to the assessee by Messrs J. K. Kothi and thereupon the assessee accepted the liability to pay the price of those goods to Messrs J. K. Kothi in future together with interest on that amount of price. Such a transaction could not be a transaction of loan and no question of borrowing of money arose.

4.4:

The Bombay High Court in the case of Dr Fredie Ardeshir Mehta Vs. UOI MANU/MH/0090/1991 = 1991 (70) Company Cases 210 Bombay has observed as under:-

As against this, Mr. Mehta, learned counsel for the respondents, emphasised that section 295 prohibited a company from giving a loan to its director without the permission of the Central Government, whether directly or indirectly. In his submission, the company had given the seventh petitioner a loan in an indirectly manner by permitting him to defer payment of the balance purchase price of the flat and pay interest thereon.

9. The essential requirement of a loan is the advance of money (or of some article) upon the understanding that it shall be returned, and it may or may not carry interest.

10. The debt here arose not out of an advance but out of the sale of the flat by the company to the seventh petitioner. The company gave to the seventh petitioner time to pay a part of the purchase price. The seventh petitioner was, thus given financial accommodation by the company in the matter of payment of the debt. Such financial accommodation was not and did not amount to a loan.

11. When section 295 refers to an indirect loan to a director, what it means is that the company shall not give a loan to a director through the agency of one or more intermediaries. The Word "indirectly" in the section cannot be read as converting what is not a loan into a loan.

WHAT IS THE MEANING OF WORD ADVANCE:

The Hon’ble Madras High Court in the case of KM. Mohammed Abdul Kadir Rowther Vs. S. Muthia Chettiar MANU/TN/0424/1959 that advance means literally a payment beforehand. In certain cases, it may be a loan but it cannot be said that a sum paid by way of advance is necessarily a loan.

The Hon’ble Privy Council in the case of Raja of Venkatagiri vs. Krishnayya Rao Bahadur MANU/PR/0017/1948  : AIR 1948 PC 150 at p. 155, has observed that ordinarily advance does not connote any idea of repayment is, therefore, clear that the word advanced used in Sec. 296 means an advance in the nature of a loan and not merely an advance as is understood in the common parlance in the sense of payment of money beforehand and which is likely to become due at some future time.

4.5: Further, at the same time, it is also beneficial to understand the distinction between “loan” and “deposit” - in view of the fact that these words have been intermittently used in the trade, industry and commerce. The distinction has been succinctly carved in a latest judgment of the Division Bench of the Hon’ble Delhi High Court in the case of Commissioner of Income Tax Vs. Vishisht Chay Vyapr Limited MANU/DE/4478/2011, in the following words:-

In any case, we would like to point out that there is a settled distinction between the loan and deposit. It is rightly held by the Tribunal, on the analysis of various judgments of our Courts which are referred to by Mr. Vohra as well and already noticed above, there are three main test between the loan and deposit. These are:(i) A loan is payable immediately on receipt thereof as per the directions of the lender, while a deposit has a term for repayment, which may be a fixed date or it may be as per terms and conditions of the agreement,

(ii) The loan is obtained at the request of the borrower while a deposit is made at the instance of the depositor and

(iii) The limitation period in case of a loan starts from the date of the loan, while it starts from the date of repayment in the case of deposit.

4.6: The Hon’ble Division Bench of Delhi High

Court has relied upon its own previous judgment in the case of Baidyanath Plastic Industries (P) Ltd. and Others v Income Tax Officer (1998) MANU/DE/0336/1997: 230 ITR 522 and that of High Court of Judicature at Allahabad in CIT v Sahara India Saving & Investment Corporation (2003) MANU/UP/0414/2003: 264 ITR 646, (i) CIT v Vikramajit Singh: MANU/DE/9358/2006: 292 ITR 274 (Del), CIT v Lakshmi Vilas Bank Ltd: MANU/TN/0270/1996: 228 ITR 697 (Mad).

4.7: The Hon'ble Supreme Court in the case of Ram Ratan Gupta v. Director of Enforcement, Foreign Exchange Regulation MANU/SC/0227/1965 held as under:The expression 'to lend' in the ordinary use means to deliver to another a thing or on condition that the thing lent shall be returned with or without compensation for use made of it by the person to whom it is lent. The subject-matter of lending also be money. Though a loan contract created a debt, there may be a debt and without contracting a loan, in other words, the concept of debt is more comprehensive than that of loan.

The Division Bench of Allahabad High Court in the case of Commissioner of Income Tax MANU/UP/1781/2014

(15) Apart from the aforesaid, the word "loan" means anything lent, especially money on interest. On the other hand, "deposit" means something which is deposited or put down, namely, a sum of money paid to secure an article, service, etc. The legislature has made a conscious distinction between the expression "loan' and "deposit". The two are not identical in meaning.

(16) In the case of a deposit the delivery of money is usually at the instance of the giver and it is for the benefit of the person who deposits the money. The benefit normally being earning of interest from the party who accepts the deposit. The deposit could also be for safe keeping or as a security for the performance of an obligation undertaken by the depositor. On the other hand, in the case of a loan, it is the borrower at whose instance and for whose needs the money is advanced.

The borrowing is primarily for the benefit of the borrower although the person, who lends the money, may also stand to gain by earning interest on the amount lent. Another distinction is the obligation to return the money so received. In the case of a deposit, the deposit becomes payable when a demand is made and, in the case of the "loan", the obligation to repay the amount arises immediately on receipt of the loan.

PAST/CONCLUDED CONTRACTS:

5. It may be appreciated that restrictions apply only at the time of entering into the transaction. For example, if a person is only an employee of the company and later on, he become director of the said company, Section 185, in my view, would not be attracted as he does not fall within list of those persons with whom contract is restricted.

At the same time, if a private Limited Company has given loan/guarantee or security provided to any of the persons mentioned above, the loan/guarantee given or security provided was earlier exempted from the provisions of Section 295 and now shall continue to be exempted under Section 185 of Act in view of the words employed in Section 185 and also in view of Section 6 of General Clauses Act. However, it cannot give further loan without complying with the provisions of Section 185 of Act.

EXEMPTED LOAN

6.The following types of loans are exempt and shall fall outside the purview of Section 185 of the Act. The proviso to Section 185(1) provides that nothing contained in this sub-section shall apply to

(a)the giving of any loan to a managing or whole-time director

(i)as a part of the conditions of service extended by the Company to all its employees; Loan could be any of the following nature:-

a) Housing Loan b) Vehicle loanb)Soft Furnishing loan c) Hard furnishing loand) Education loan e) Marriage loanf)Religious, Social, Traditional & Customary ceremonies and functions.g) Loan against Foreign Visits

If the proposed loan is not covered as a part of conditions of services, the company may, by passing a board resolution, amend the service conditions and uniformally and provide for giving of loan to all employees subject such approval either by Board or its Committee thereof;

(b): pursuant to any scheme approved by the members by a Special Resolution; or Under this head, if the proposed loan is not covered as a part of conditions of service, then the company may formulate “Scheme” to cover giving loan under any of the above “Head” but, of course, such Scheme must be approved by way of Special Resolution.

The Section 185(1) of Companies Act, 2013 has been amended permitting the holding company giving of (i) loan to its wholly owned subsidiary company or (ii) providing security (iii) guarantee to wholly owned subsidiary company by any person. Further, the amendment also permit the holding company to give (i) guarantee (ii) or security in respect of loan made by any bank or financial institutions to its subsidiary company; provided that the loans are utilized by the subsidiary for its principal business activities.

In other words, the subsidiary company, in turn, cannot give loan (out of the above loan) but can use the loan for its main or predominant or principal business activities. However, any company, side by side, can have more than one principal business activities – in other words mult- disciplinary or multi-product or multi-purpose company. In my view, the law no where says that there can be only one principal business activities.

The ITAT in the case of Sandvik Asia (P) Ltd Vs. Asstt Commissioner of Income Tax MANU/IP/0096/2013 has observed as under

In brief, the background of the dispute is that assessee is a company incorporated under the provisions of the Indian Companies Act, 1956 and its principal activities comprised manufacturing, trading and regrinding of tungsten carbide tools, rock processing equipments, thermostatic electrical bimetal strips, wires, ribbons, heating elements, cold finished tubes/pipes and manufacturing of hot extruded seamless stainless steel tubes/pipes, etc.. The business of the company was divided into three segments, which read as under:-

(i)Tooling-specialises in tools for metal cutting.

(ii) Mining and Construction-focuses on tools and service for mining and construction contracts with respect to compressing of crushing plants used in mines.

(iii) Materials Technology-Specialises in high value added products metallic materials.

(c) A company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India. A question arises as to what is the meaning of the word “in the ordinary course of its business” in relation to loan

WHAT IS MEANT “IN THE ORDINARY COURSE OF ITS BUSINESS: The Hon'ble Supreme Court in the case of State of Gujarat v. Raipur Manufacturing Co. Ltd. MANU/SC/0223/1966  : [1967] 19 STC 1(SC) has defined any activity to be called as “business” in the sense of an occupation, or profession which occupies the time, attention and labour of a person, normally with the object of making profit. To regard an activity as "business" there must be a course of dealings, either actually continued or contemplated to be continued with a profit motive, and not for sport or pleasure.

In Essen Private Ltd. v.Commissioner of Income tax

Madras, MANU/SC/0022/1967  : [1967]65ITR625(SC) the appellant carried on business as a managing agent of several concerns. Pursuant to the agreement with one of the companies managed by it, it advanced large-sums of money to the managed company and also guaranteed a loan of Rs. 2 lakhs obtained by that company from a Bank. The managed company failed in its business and upon the Bank pressing for payment the appellant in accordance with its guarantee made certain payments to that Bank. The assessee had ultimately to write off certain sum in its books as bad debts and it claimed that allowance under Section 10(1)(xi). The Tribunal found that the advances to the managed company and the agreement guaranteeing the loan to the managed company were in pursuance of its objects and were made in the course of its business and the claim was allowed.

That decision was finally affirmed by this Court. In this case there was a clause in the memorandum of association by which the assessee was entitled to lend monies and to guarantee the performance of contracts. Similarly the managing agency agreement contained a Clause about lending and advancing of money to the managed company. It was found by the appellate tribunal that it was a part of the managing agency to provide funds to the managed company. In the present case none of those facts have been found. Neither the memorandum of association nor the managing agency agreement contained any such provision by which it could be said that the guaranteeing of the loan made by the Bank to the selling agents was done in the course of the managing agency business..

The Supreme Court in the case of SA Builders (P) Ltd Vs. CIT MANU/SC/8798/2006, on the issue of giving loan by a company to its sister/group/associate company, has observed as under:-

It is true that the borrowed amount in question was not utilized by the assessee in its own business, but had been advanced as interest free loan to its sister concern. However, in our opinion, that fact is not really relevant. What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency. The interest on the borrowed funds (so lent) was ultimately allowed by the Supreme Court.

The Division Bench of the Allahabad High Court in the case of Commissioner of Income Tax Vs. Atul Engineering Udyog, MANU/UP/1781/2014 has observed, in the light of the facts, as under:-

FACTS:

The assessee was incurring heavy losses. On the other hand, the sister concern was unable to utilise the natural gas that was being supplied by M/s. Gas Authority of India Limited (hereinafter referred to as "GAIL") under a contract wherein the sister concern was under an obligation to obtain 80% of the quantity of gas as a minimum guarantee.

The assessee had generators worth Rs. 93 lacs for the purpose of generating power, but had no gas. Accordingly, an agreement was executed between the assessee and its sister concern whereby generators were supplied by the assessee for which a floating security deposit of Rs. 80 lacs was given by the sister concern. In this agreement, the sister concern was to use the generators and generate electricity on the basis of the gas supplied by the GAIL. In return, the sister concern would supply electricity to the assessee at concessional rate. 

RATIO OF THE CASE:

17. In the light of the aforesaid, we find that the deposit made by the sister concern was a business transaction arising in the normal course of business between the two concerns.

The Division Bench of Allahabad High court in the case of Kishori Lal Vs. CIT MANU/UP/0904/2014, while dealing with the issue of giving loan as permitted as a part of Ancillary Object and not as a Main Objects, has held under:-

In holding that the advance was not in the ordinary course of business, the sole consideration which weighed with the Tribunal was that the main object of the two companies was not to engage in money-lending business, though the ancillary object was to invest and deal with the funds of the company not immediately required, in such investments or securities and in such manner as shall from time to time be considered necessary for the benefit of the company.

The Tribunal was of the view that the two companies were not involved in the business of money-lending. Consequently, the Tribunal came to the conclusion that since the main object of the two companies was not money-lending but the companies were permitted to invest their surplus funds for the time being, this could not be regarded as being in the ordinary course of the business.

Findings of Hon’ble High Court

Moreover, where the advance or loan was made in the ordinary course of the business of the company, the fact that the lending of surplus funds is not part of the main object but is at the same time permissible as an ancillary object would not detract from the loan or advance being made in the ordinary course of its business.

6.1: Further, any transaction of making any loan or giving any guarantee or providing any security in connection with a loan made by any other person to, or to any other person, will not apply to:-

a) Any loan made to an employee of the company, who is not a relative of any director; (ii) any

loan or advance made to a trust in which directors are trustees;b) Any quasi-loan;c) Any advance or deposit made in connection with the leasing/hire purchase transaction;d): Any advance payment of salary given to an employee who is a relative of a director as per the rules of the company;

e).Any investment made in acquiring residential accommodation for director(s) (whether by way of purchase or entering into a lease agreement);

f):House building loan given to a director subject to the guidelines issued for that purpose by the Central Government;

g):Any loan made to a Registered Co-operative Society;h).Advance given for services to be rendered or goods to be supplied provided it is reasonable and commensurate with the services to be rendered or goods to be supplied;

i):To a government company provided that such company has obtained the approval of the Ministry or Department of the Central Government, which is administratively in charge of the company, or as the case may be or the State Government; 

6.2 Further, Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014 provides the following exemptions in relation to transactions by the holding company with its subsidiary company under Section 185. 6.3 Exemptions to the holding company for its wholly owned subsidiary company –

Rule 10 (1) provides that;

(a) any loan made; or(b)any guarantee given; or© any security provided;

by a holding company in respect of any loan made to its wholly owned subsidiary company is exempted from the requirements under Section 185 of the Companies Act, 2013 provided, however, such loans are utilized by the subsidiary company for its principle business activities.

6.4 Exemptions to the holding company for its subsidiary company

Rule 10(2) provides that;(a) any guarantee given; or(b) 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 Section 185 provided, however, such loans are utilized by the subsidiary company for its principle business activities.

6.5: The MCA, in relation to Section 185 of Companies Act, 2013, by General Circular No.03/2014, dated 14.02.2014, has issued the following clarification:

(1) This Ministry has received number of representations on the applicability of Section 185 of the Companies Act, 2013 with reference to loans made, guarantee given or security provided under Section 372A of the Companies Act, 1956. The issue has been examined with reference to applicability of Section 372A of the Companies Act, 1956 vis-à-vis Section 185 of the Companies Act, 2013. Section 372A of the Companies Act, 1956, specifically exempts any loans made, any guarantee given or security provided or any investment made by a holding company to its wholly owned subsidiary. Whereas, Section 185 of the Companies Act, 2013 prohibits, guarantee given or any security provided by a holding company in respect of any loan taken by its subsidiary company except in the ordinary course of business.

In order to maintain harmony with regard to applicability of Section 372A of the Companies Act, 1956 till the same is repealed and Section 185 of the Companies Act, 2013 is notified, it is hereby clarified that any guarantee given or security provided by a holding company in respect of loans made by a bank or financial institution to its subsidiary company,

exemption as provided in clause (d) of sub-section (8) of Section 372A of the Companies Act, 1956, shall be applicable till Section 186 of the Companies Act, 2013 is notified. This clarification will, however, be applicable to cases where loans so obtained are exclusively utilized by the subsidiary for tis principal business activities.

7. PENALTY FOR CONTRAVENTION:

The Section 185(2) provides that if any loan is advanced or a guarantee or security is given or provided in contravention of the provisions of section 185(1), the company shall be punishable with fine which shall not be less than Rs. 5 lakhs but which may extend to Rs. 25 lakhs, and the director or the other person to whom any loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the other person, shall be punishable with imprisonment which may extend to 6 months or with fine which shall not be less than Rs. 5 lakhs but which may extend to Rs. 25 lakh, or with both.

8. Under the new dispensation of Section 185, the provisions have been more rigorous. It would be useful for the trade and industry, if the invest is allowed by a private companies which are more or less in the nature of family company.

 

Thank You