Are Directors of a Company Allowed to Take a Loan from the Company

Are Directors of a Company Allowed to Take a Loan from the Company

In the case of a partnership firm or proprietorship concern, partners and proprietors withdraw funds from the business as and when they need it to meet their daily personal expenses. The same viewpoints generally people carry for the company as well that they can withdraw funds from the company as and when required. However, this is not the case. Each and every transaction with the directors of the company is bound by the Companies Act, 2013.

So, if you are seeking an answer to the question of whether directors can take from the company then the answer is partial yes.

In this article, you will find that though the company law restricts the direct providing of loans to directors, it still allows loans to directors in some cases and also allows parties in whom any director is interested to obtain a loan from the company with some conditions.

1. General prohibition for granting loans or guarantees to directors by a company

  • In terms of provisions of section 185 of the Companies Act, 2013, a company is not allowed to provide any loan (including a loan represented by a book debt) to:
    • its director; or 
    • director of a holding company; or 
    • Any relative or partner of such director; or
    • Any firm in which such a director or relative is a partner
  • Further, The company is not allowed to provide any guarantee or security in connection with any loan taken by the above-mentioned persons.

For the purpose of this section, The term ‘relative’ includes father, mother, brother, spouse, sister, son, son’s wife, daughter, daughter’s husband, and member of HUF.

2. Allowability of loan to the director by a company in some cases

The Companies Act does not prohibit granting of loans completely. Companies Act has permitted granting loans in the following cases:

  1. Loans to Managing Director or Whole Time Director:
    • Prohibitions given u/s 185 are not applicable to any loan given to a managing director or a whole-time director.
    • Provided that such a loan should be given as a part of the conditions of service extended by the company to all its employees; or pursuant to any scheme approved by the members by a special resolution.
  1. Loans by Company engaged in the business of granting loans and guarantees:
    • Above mentioned prohibition is not applicable to a company that in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan.
    • Provided that interest on such loan is charged at a rate not less than the rate of prevailing yield of one year, three-year, five-year, or ten years Government security closest to the tenor of the loan; 

3. Loans to any person in which the director of the company is interested

  • As per Section 185(2) of the Companies Act, A company is allowed to provide any loan or guarantee or any security in connection with any loan taken by any person in whom any of the directors of the company is interested.
  • However, this loan can be granted subject to the following conditions:
    • A special resolution is passed by the company in a general meeting. The company shall disclose the complete particulars and purpose of the loan in the explanatory statement to the notice.
    • the loans are utilized by the borrowing company for its principal business activities.
  • Any person in whom the director of the company is interested means:
    • any private company of which any such director is a director or member;
    • any body corporate in which 25% or more of voting power is owned or controlled by any such director, or by two or more such directors, together; or
    • 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 of any director or directors, of the lending company.
  • let’s understand who is a party in which a director of the company is interested in the following illustrations.
    • Any private company of which any such director is a director or member. 
      • Mr. Abhishek is a director of B Ltd and also holds a directorship in X Ltd. 
      • In this case, X Ltd. is an entity treated as a person in whom Mr. Abhishek is interested. Therefore, B Limited is permitted to provide loans to X limited and vice versa.
  • Anybody corporate in which director or two or more directors hold 25% or more voting power:
    • Mr. Raj is having 55% shareholding in A Ltd in turn held 70% in Y Ltd. and 15% in Z Ltd. 
    • In this case, Mr. Raj’s voting power will be 55% in A Ltd., 38.5% (55%*70%) in Y Ltd., and 5.77% in Z Ltd. 
    • Therefore, A Ltd. and Y Ltd. are covered in the category of person in whom Mr. Raj is interested; or

4. Required approvals for providing loans to the director, etc.

In certain cases, the company is permitted to grant a loan to its director or any person in which the director of the company is interested. Provided such loan can be granted subject to fulfilling of the following condition:

a. Loan to Whole Time Director or managing director:

  • The loan can be granted to a whole-time director or managing director pursuant to a scheme.
  • Provided that such a scheme is approved by members through a special resolution.

b. Loan to entities in which the director is interested:

  • A Company is allowed to provide a loan to any person in whom directors are interested (as discussed above) subject to the condition that such lending is approved by members through passing a special resolution in a General meeting.
  • An explanatory statement attached to the notice of the general meeting should disclose all particulars of the loans given or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient and any other relevant fact.

c. Loans exceeding the specified threshold limit

  • A company providing a loan or guarantee or security in connection with that loan has to obtain shareholders’ approval via special resolution where the aggregate of the loan, investment, guarantee, or security already made together with the loan, investment, guarantee, or security proposed to be made exceeds 
    • 60% of paid-up capital and free reserves and securities premium or 
    • 100% of free reserves and securities premium whichever is higher.

5. Interest on loan to a director, etc.

While the Companies Act, 2013 does not provide any interest rate except for a company whose normal course of business is money lending, a loan can be provided at a concessional rate or it may be interest-free.

6. Treatment of Loan to directors under the Income-tax Act

  • A private company providing a loan to its director may attract provisions of section 2(22)(e) of the Income Tax Act, 1961 i.e. deemed dividend
  • Tax at the rate of 30% on the deemed dividend is to be paid by the private company once conditions of section 2(22) (e) are satisfied and it is proved that the dividend is deemed to be paid by a private company. 
  • According to the provisions of section 2(22)(e) of that Act, any loans or advances given by a private company to the extent it possesses accumulated profit to any of the following persons will be treated as deemed dividend:
    • A shareholder who is the beneficial owner of shares (not entitled to a fixed rate of dividend), and holds a minimum of 10% of the voting rights. Here, a director of a private company who is also a shareholder of at least 10% of voting rights is to be considered for our discussion purposes.
    • Any concern in which the shareholder of the company is a member or partner holding a substantial interest.
    • On behalf, of, or for the individual benefit of such shareholders, to the extent specified by law.

Therefore, a director should do analysis before obtaining a loan from a private company since most of the loan amount would get taxed under the Income Tax once treated as deemed dividends. Other options of taking loans from banks or financial institutions can also be looked into in such cases.

7. Violation of provisions results in penalty & prosecution

In case there is a default in complying with any provision relating to providing of loan, guarantee, or security in connection with that loan:

  1. The company shall be punishable with a fine, not less than INR 5 Lacs but up to INR 25 Lacs.
  2. The Director of the company to whom the loan is granted shall be punishable with imprisonment up to 6 months or fine of minimum INR 5 lacs and up to INR 25 Lacs or both.

8. Miscellaneous points

Disclosure by the director of a company about interest in a contract or arrangement or its shareholding in another company.

A director is bound to inform a company about its interest in any contract or arrangement or its shareholding in any other company. Therefore, having a loan from a company or a loan obtained by any person in whom the director is interested needs to be intimated to the company itself and other companies where he/she holds directorships.

Register of loans to record loans to a director, etc.

Every company maintains a record of loans or investments in the register of loans, investments, etc. Once the loan is granted to a director, proper recording should be made in that register by administrators.

Granting a loan by a director to the company.

A reverse of what we are discussing is also possible. That is, a director can also grant to a company since it is nowhere prohibited in the Company law. It should be kept in mind that funds used for providing loans by directors should be personal funds of the director and are not a part of any cycle of misuse of funds of any company.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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