Loans to Director of Private Limited Company

Provisions under Companies Act,2013

Section 185(1) provides that ‘No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by, –

(a) any director of company, or of a company which is its holding company or any partner or relative of any such director; or

(b) any firm in which any such director or relative is a partner.’

Exemptions from Section 185

Government exempted private companies from entire Section 185 to ease the compliance requirement vide notification dated 5th June, 2015, subject to following 3 conditions:

1. There should be no investment in the concerned company from any other body corporate;
2. The company should not have any borrowings from banks, financial institutions and other body corporate equal to or more than twice its paid up share capital, OR Rs. 50 crores, whichever is lower; and
3. There should be no subsisting default at the time of making such transaction, and that the company should have the capability to pay off the loan.

Penal Provisions

If any loan is advanced or a guarantee or security is given or provided or utilized in contravention of the provisions of this section, –

1. The company shall be punishable with fine between Rs. 5,00,000 to Rs. 25,00,000.
2. Every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to six months or with fine between Rs. 5,00,000/- to Rs. 25,00,000/- and
3. 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 six months or with fine between Rs. 5,00,000/- to Rs. 25,00,000/- or with both.

Provisions under Income Tax Act,1961

Section 2(22)(e) of the IT Act 1961 deals with the issue of “deemed dividend.”

“Dividend” includes – any payment by a company, not being a company in which the public are substantially interested, of any sum by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;

Conclusion

Though The Private Limited Company fulfils certain conditions as mentioned in Section 185 of Companies Act, One should be more concerned about the transaction as per the Income tax Act Since any loan given by Company to shareholder will straightaway be taxed in the hands of the shareholder as Deemed dividend under section 2(22) (e) and wef from A.Y 2019-20, the company giving such loan or advances shall be liable to pay tax, that is, dividend distributed tax 30% and not the recipient. Hence it is practically not feasible to give loan to Director.