FAQ ON SEC 185 ALONG WITH PLANNING

FAQ ON SEC 185 ALONG WITH PLANNING

Q1:  What are the prohibitions on sec 185?

Ans:

•       No company can directly or “indirectly” advance loan to its “directors” or to “other persons in whom directors are interested”.

•       No company can give any guarantee or provide any security in connection with any loan taken by

him or such other person.

•       Company can’t give loan represented by a book debt to above mentioned person”.

Q2: What is the meaning of word “indirect” under sec 185?

Ans: The word ‘indirect’ used means that the co does not give a loan to director through the agency of one or more intermediaries. The word ‘indirect’ cannot be read as converting what is not a loan into a loan. [Dr. Fredie Ardeshir Mehta V Union of India (1991) 70 Comp Cas 210]

Q3: What is the meaning of phase, “other persons in whom directors are interested”.

Ans:

(a) INDIVIDUAL: Director of  lending co., or holding co. or any partner or relative of any  “such director”;
(b) FIRM: in which any such director or relative is a partner;
(c) PVT LTD CO: of which  such director is a director or member;

[Note - Relative of Director are not covered  under this sub clause]

(d) BODY CORPORATE at a general meeting of which at least 25 % of  voting power may be exercised  or “controlled” by such director, or by two or more such directors, together; or
[Note - Relative of Director  also not covered  under this sub-clause]

(e)BODY CORPORATE Board, MD or manager, whereof is accustomed to act in accordance with  directions or instructions of  Board, or of any director or directors, of  lending company.

Q4: What is the meaning of word “control”?

Ans: "Control" has been defined as to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholding or management rights or shareholders agreements or voting agreements or in any other manner. [ u/s 2(g)]

Q5: What are the exceptions to sec 185?

Ans:

a)      MD/WTD - 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; or 
(ii)               Pursuant to any scheme approved by the members by a special resolution;
b)      ORDINARY COURSE - 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 RBI. 

Q6: What is the meaning of the term “ordinary course of lending”?

Ans: TWO TEST(MY VIEW) :

•       If the company is engaged in lending activities  regularity &

•       Lend  not only to directors/directors’ entities but also to “arms’ length parties/unrelated parties”

Q7: What is the meaning of word “Loan”?

Ans: Loan has not been defined under Co Act. Any transaction of giving money to be returned in money with or without interest can be treated as “loan”. 

Q8: Is advance covered by sec 185?

Ans: ADVANCE NOT COVERED BY SEC 185. Normally an advance is not repayable as an advance .It usually conveys an idea of a prepayment, that is, paying something in advance before it is actually due.

Q9: Are All NBFCs engaged in “lending activities in ORDINARY COURSE”?

Ans: May not be. Refer  tests under Q6.

Q10: What is the penalty u/s 185?

Ans:

•       Lender Company – Fine Rs. 5 lakhs to Rs. 25 lakhs &

•       Receiver: Director or other person to whom any loan is advanced or guarantee or security is given -Imprisonment upto 6 months or fine Rs. 5 lakhs to Rs. 25 Lakhs, or both.

Q11: Are guarantee & letter of comfort covered by sec 185?

Ans: Guarantee has been covered, however, letter of comfort is not covered by sec 185.

Q 12What is the difference between guarantee & letter of comfort?

Ans:

•       In case of Guarantee, guarantor undertakes the liability of principal debtor, whereas

•       In case of letter of Comfort, intention is to give introduction of debtor,  without undertaking the liability of principal debtor

Q 13 Is Loan given before 12^th Sep, 2013 affected by sec 185?

Ans:

•       Existing loan/guarantee/security provided before 12th Sep, 2013 is not affected by above provisions. However, it should not be renewed & should be repaid on due date.

•       “Loan repayable on demand” should be repaid on demand.

•       “Loan repayable after fixed period” should be repaid on expiry of Fixed period.

Q14  If there any contravention of sec 185 if share application money/advance for property/goods/services is given to specified person u/s 185 on or after 12^th sep , 2013?

Ans : No, there is no contravention. However, private placement provisions have to be complied, if share application money is given on or after 1^st April, 2014.

 Q15 Can Loan given by subsidiary to holding co. & Vice versa?

•       Ans: Assuming that directors of subsidiary co. (as well as “other persons in whom directors are interested”) do not hold any shares in holding co, Sec. 185 is not attracted.

MAY NOT COVERED IN

•       Clause (a) (as applicable for individual) or

•       Clause (b) (as applicable for Firm),

•       Clause (c) (for Pvt Ltdco.,only if director is a director or member),

•       Clause (d) (only if the director either by himself or two or more such directors hold 25% or more of total voting power in the borrowing company,

•       Clause (e) (only if borrowing company /its Board/Directors are accustomed to act as per the Directors of the board/Directors of the lending company.

Kindly note that to attract Sec. 185, any interest of director (or other person) in his “personal capacity (not holding as nominee of company)” is relevant. Interest of holding co. in subsidiary is not relevant.

Same will be position in case of vice versa relationship.

Q16 What are the specific exemptions provided to loan given by holding co to subsidiaries?

Ans: Rule

(1)   Any loan made by a holding co to its wholly owned subsidiary co or any guarantee given or security provided by a holding co in respect of any loan made to its wholly owned subsidiary co is exempted from the requirements under this section; and

(2)   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 is exempted from the requirements under this section:
Provided that such loans made under sub-rule (1) and (2) are utilised by the subsidiary company for its principle business activities.

Q17:  What are the planning for sec 185?

Ans:

1)      Convert  both Lender co & receiver co to LLP or

2)      Convert other co (to whom loan is given) to public Ltd to enjoy 25% limit or

3)      Rearrange shareholding pattern & directorship pattern:

a)Appoint new directors in lender Co, who personally neither hold any share in other co nor are directors in other co. If their relatives holds shares or are directors than there is no problem or

                b) One can gift  shares to other relative to rearrange shareholding pattern

Q18:  What are the benefits if private Ltd Co is converted into LLP as mentions in Q17?

Ans:

1)      LLP is not a company, hence limit of audit of 20 company  will not be applicable.

2)      As Companies Act will not be applicable, you can transfer fund from one LLP to another group LLP.

3)      Many of exemption which Pvt Ltd company enjoy under old Companies Act has been withdrawn, which are not applicable to LLP.

4)      Compliances under new companies Act for Pvt Ltd Companies has been substantially increased, which are not applicable for LLPs.

5)      There is heavy penalty for non compliances under New Company Act. Penalty of Rs 50,000 is a small amount for a single violation.

6)      Cost benefit analysis suggests that these should be converted into LLP.
7)       However, as per Sec 47(xiiib) of Income tax Act, for tax neutrality of such conversion , turnover of Pvt Ltd company  in any of last 3 years must not exceeds 60 lakhs. So, if turnover exceeds 60 lakhs than such conversion will be subject to income tax.

Q 19 How to rearrange shareholding & Directorship pattern as referred in Q17 above?

Ans: Suppose A,B,C,D are 4 members in a family. They have 2 Cos: A Pvt Ltd & C Pvt Ltd.

i) We can appoint A& B as directors of A Pvt Ltd. & gift all shares in name of C & D in A Pvt Ltd to A & B.

ii) We can appoint C& D as directors of C Pvt Ltd  & gift all shares in name of A & B in C Pvt Ltd to C & D.

Q20: Is there any extra care while rearranging directorship & shareholding patter?

Ans:  It is suggested to appoint dependent relative in Lender Company as director.   

Clause d states that BODY CORPORATE at a general meeting of which at least 25 % of  voting power may be exercised  or “controlled” by such director, or by two or more such directors, together is covered by sec 185. "Control" has been defined as to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholding or management rights or shareholders agreements or voting agreements or in any other manner. [ u/s 2(g)].

Dependent relatives are not expected to control relative on which they are dependent. If dependent relatives are appointed in lender company & the relative on whom they are dependent is appointed as director in the company to which loan is to be given, there will be comparatively less chances to attract sec 185.