Loans under Companies Act 1956/2013

Loansunder Companies Act 1956/2013 P C Agrawal B.Com., LL.B., CAIIB, FCS cs.pcagrawal@gmail.com 20/2/2014 Download Source- www.taxguru.in

Contents

MCA Notification dated 12.9.2013 In exercise of the powers conferred by sub-section (3) of section 1 of the Companies Act 2013 (18 of 2013), the Central Government hereby appoints the 12th day of September 2013 as the date on which the following provisions of the said Act shall come into force, namely: ….. …. Sd/- RENUKA KUMAR Joint Secretary to the Government of India

MCA circular dated 18.9.2013 on notification of 98 new sections This Ministry had issued a notification on 12.09.2013 bringing into force to 98 sections or part thereof of the Companies Act 2013. The said notification is available on Ministry’s website. This Ministry has been receiving requests for clarification as to whether the provisions of the Companies Act 1956 corresponding to such 98 sections would continue to apply or not. It is hereby clarified that with effect from 12.09.2013, the relevant provisions of the Companies Act 1956, which correspond to provisions of 98 sections of the Companies Act 2013 brought into force on 12.09.2013 cease to have effect from that date. This issues with the approval of the competent authority.

Sections relating to loans

Loans to directors & related parties

Meaning of ‘in the ordinary course of business’ in Section 185 of CA 2013

Meaning of ‘Save as otherwise provided in this Act’ in Section 185 of CA 2013

Definition of ‘body corporate’ Section 2(7) of 1956 Act: “body corporate” or ‘corporation’ includes a company incorporated outside India but does not include— • A corporation sole; • A cooperative society registered under any law relating to cooperative societies; and • Any other body corporate (not being a company as defined in this Act) which the Central Govt. may by notification in the Official Gazette, specify in that behalf. Section 2(11) of 2013 Act: Same [except that (a) – a corporation sole deleted] General characteristics: • Incorporated under some law • Perpetual succession • Common seal • Legal entity apart from the members

Definition of ‘body corporate’ Examples of ‘body corporates’: • All companies registered under Indian Companies Act • All companies registered under any Act outside India • Any Corporation registered under any special law in India or abroad • Public financial institutions u/s 4A of Companies Act 1956 • Nationalised banks incorporated under Banking Companies (Acquisition & Transfer of Undertakings) Act 1970 • LLPs These are not bodies corporates: • Proprietorship concerns • Partnership firms (other than LLPs) • HUFs • Societies registered under Societies Registration Act • Mutual funds managed by trustees (except UTI)

Definition of ‘relatives’ under CA 1956 Section 2(41): “relative” means, with reference to any person, any one who is related to such person in any of the ways specified in section 6, and no others. Section 6: A person shall be deemed to be a relative of another if, land only if, -- • They are members of a Hindu undivided family; or • They are husband and wife; or • The one is related to the other in the manner indicated in Schedule 1A. Schedule 1A [See Section 6(c)] LIST OF RELATIVES • Father • Mother (including step-mother) • Son (including step son) • Son’s wife • Daughter (including step daughter) • Father’s father • Father’s mother • Mother’s mother • Mother’s father • Son’s son • Son’s son’s wife • Son’s daughter • Son’s daughter’s husband • Daughter’s husband • Daughter’s son • Daughter’s sons’s wife • Daughter’s daughter • Daughter’s daughter’s husband • Brother (including step-brother) • Brother’s wife • Sister (ioncluding step sister) • Sister’s husband

Definition of ‘relatives’ under CA 2013 Section 2(77): “relative” with reference to any person, means any one who is related to another, if— • They are members of a Hindu undivided family; or • They are husband and wife; or • One person is related to the other in such manner as may be prescribed. Thus it will be noticed that the following are proposed to be omitted from list of relatives: • Son’s son’s wife • Son’s daughter’s husband • Daughter’s son • Daughter’s son’s wife • Daughter’s daughter • Daughter’s daughter’s husband • Brother’s wife • Sister’s husband Draft Rule 1.4(yet to be notified) LIST OF RELATIVES For the purpose of sub-clause (iii) of sub-section (77) of Section 2, a person shall be deemed to be the relative of another, if he or she is related to another in the following manner: • Spouse • Father (including step father) • Father’s father • Father’s mother • Mother (including step-mother) • Mother’s mother • Mother’s father • Son (including step-son) • Son’s wife • Son’s son • Son’s daughter • Daughter (including step daughter) • Daughter’s husband • Brother (including step brother) • Sister (including step sister)

Meaning of ‘control’ Section 2(27) of Companies Act 2013: “control” shall 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 shareholders agreement or voting agreements or in any other manner.”

Meaning of ‘Loans’ Loans vs. Deposits: Loan is lending of money with absolute promise to repay. There is a difference between loan and deposit. However, courts have held that for the purposes of Sec.295 of CA 1956 the difference is immaterial and the Section cannot be evaded by describing monies of a company advanced to a director as deposits. Sec.372A of CA 1956 specifically provides that loan includes deposits. However, there is no such mention in CA 2013. Loans vs. advance: There is a difference between loan and advance also. Loan is repayable whereas advance is to be adjusted against supply of goods or services. Salary advance is an example. Advance is not covered under restrictive provisions of Companies Act. Whether subscription of debentures is a loan? Subscription of debentures is not a loan u/s 185 of CA 2013. However, Sec.372A of CA 1956 specifically provides that loan includes debentures. Whether book debts could be loans? If book debt is prolonged beyond usual credit period, it could be considered as a loan.

Bank rate declared by RBI Source: http://www.dicgc.org.in/English/FB_BankRate.html

Section 462 of CA 2013 Power to exempt class or classes of companies from provisions of this Act. • The Central Government may in the public interest, by notification direct that any of the provisions of this Act, -- • Shall not apply to such class or classes of companies; or • Shall apply to the class or classes of companies with such exceptions, modifications and adaptations as may be specified in the notification. (2) …..” Note: No exemption notification has been issued by MCA so far under Section 462 of CA 2013.

Section 2(22)(e) of Income Tax Act relating to deemed dividend Loan given to shareholder holding more than 10% of voting power could be deemed to be dividend. Section 2(22)(e) of IT Act reads as under: • “In this Act, unless the context otherwise requires— • (22) ‘dividend’ includes: • (e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) [made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) 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 (hereafter in this clause referred to as the said concern)] 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 ;

Section 2(22)(e) of Income Tax Act relating to deemed dividend but "dividend" does not include— (i) a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ; (ia) a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964, and before the 1st day of April, 1965 ; (ii) any advance or loan made to a shareholder or the said concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company ; (iii) any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off; [(iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A5 of the Companies Act, 1956 (1 of 1956); (v) any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company).

Section 2(22)(e) of Income Tax Act relating to deemed dividend Explanation 1.—The expression "accumulated profits", wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956. Explanation 2.—The expression "accumulated profits" in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation, 6[but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place. Explanation 3.—For the purposes of this clause,— (a) "concern" means a Hindu undivided family, or a firm or an association of persons or a body of individuals or a company ; (b) a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the income of such concern ;

Extracts from RBI Act relating to NBFC Section 45-I: (c) ‘financial institution’ means any non-banking institution which carries on as its business or part of its business any of the following activities, namely --- • the financing, whether by way of making loans or advances or otherwise, of any activity other than its own; • the acquisition of shares, stocks, bonds, debentures or securities issued by a Government or local authority or other marketable securities of a like nature; • ….. …….. but does not include any institution, which carries on as its principal business, ---- …… (b) Industrial activity, or …… (f) ‘non-banking financial company’ means --- • a financial institution which is a company; or • ……

Extracts from RBI Act relating to NBFC RBI Press Release dated 8.4.1999 The Reserve Bank of India on 8.4.1999 announced that in order to identify a particular company as a NBFC, it will consider both, the assets and the income pattern as evidenced by the last audited balance sheet of the company to decide its principal business. The company will be treated as NBFC if its financial assets are more than 50 percent of its total assets (netted off by intangible assets) and income from financial assets should be more than 50 percent of the gross income. Both these tests are required to be satisfied as the determinant factor for principal business of a company. Section 45-IA: (1) Notwithstanding anything contained in this Chapter or in any other law for the time being in force, no non-banking financial company shall commence or carry on any business of a non-banking financial institution without --- • Obtaining a certificate of registration issued under this Chapter; and • Having the net owned fund of twenty-five lakh rupees or such other amount, not exceeding two hundred lakh rupees, as the Bank may, by notification in the official gazette, specify.

Other points relating to loans/ guarantees • Loans may or may not carry interest • Excess remuneration paid could be treated as a loan • Sale on credit is not loan [Bombay High Court in FredieArdeshir Mehta v. Union of India (1991)] • Whether letter of comfort is a guarantee? Letter of comfort may involve moral obligation but not contractual obligation and is not a guarantee and hence not covered under restrictive provisions of the Act. • Government had issued guidelines on 12.11.1976 for loans to directors for house building without approval of CG.

Inter-corporate loans & investments (Sec.372A of CA 1956)

Inter-corporate loans & investments (Sec.372A)

Inter-corporate loans & investments (Sec.372A) Contd…

MCA circular dated 19.11.2013 on Sec.372A This Ministry has received number of representations consequent upon notifying Section 185 of the Companies Act 2013 dealing with loans to directors which is corresponding to Section 295 of the Companies Act 1956. Section 186 of the Companies Act 2013 is yet to be notified. It is clarified that Section 372A of the Companies Act 1956 dealing with inter-corporate loans continue to remain in force till section 186 of the Companies Act 2013 is notified. This issues with the approval of competent authority.

MCA Valentine Day circular dated 14.2.2014 on Sec.185 of CA 2013 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. 2. 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 utilised by the subsidiary for its principal business activities.

MCA circular dated 4.6.1999 on section 372A The provisions in the Companies Act, 1956, relating to inter-corporate investments, loans and guarantees have been recently liberalised by the Government through Companies (Amendment) Act, 1999. However, apprehensions have been expressed in some quarters with regard to possible misuse of these provisions by companies. I shall, therefore, be grateful if the chambers could draw the attention of their constituents to the following: (i) The companies are expected to obtain the approval for making investments into securities or grant of loan to other companies of amounts which are linked with company’s available financial resources and the resolution, for investment much beyond the networth should not be passed by the companies. (ii) The companies should specifically indicate in the explanatory statement to the resolution, the specific securities in which it is proposed to invest the amount. En bloc approval should normally be avoided (except in the case of guarantee where the resolution can indicate an amount on annual basis). 2. If the above broad parameters are not complied with, the Government will be constrained to take suitable action against those who contravene these. Circular : No. 8 of 1999, dated 4-6-1999.

Borrowing

CBDT circular dated 11.2.2014on disallowance u/s 14A of IT Act Section 14A of the Income-tax Act 1961 (‘Act’) provides for disallowance of expenditure in relation to income not ‘includible’ in total income. • A controversy has arisen in certain cases as to whether disallowance can be made by invoking section 14A of the Act even in those cases where no income has been earned by an assessee which has been claimed as exempt during the financial year. • The matter has been examined in the Board. It is pertinent to mention that section 14A of the Act was introduced by the Finance Act 2001 with retrospective effect from 01.04.1962. The purpose for introduction of section 14A with retrospective effect since inception of the Act was clarified vide Circular No.14 of 2001 as under: “Certain incomes are not includible while computing the total income, as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tas incentive given by way of exemptions to certain categories of income is being used to reduce aslo the tax payable on the non-exempt income by debiting the exepenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation whereby only the net income, i.e. gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of such taxable income”.

Thus, legislative intent is to allow only that expenditure which is relatable to earning of income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not. • The above position is further clarified by the usage of term ‘includible’ in the Heading to section 14A of the Act and also the Heading to Rule 8D of I.T. Rules, 1962 which indicates that it is not necessary that exempt income should necessarily be included in a particular year’s income, for disallowance to be triggered. Also, section 14A of the Act does not use the word ‘income of the year’ but ‘income under the Act’. This also indicates that for invoking disallowance under section 14A, it is not material that assessee should have earned such exempt income during the financial year under consideration. • The above position is further substantiated by the language used in Rule 8D(2)(ii) & 8D(2)(iii) of I.T. Rules which are extracted below: “(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt an amount computed in accordance with the following formula, namely: A*B/C

Where…. B= the average of value of investment, ;income from which does not or shallnot form part of the total income as appearing the in the balance sheet of the assessee, on the first day and the last day of the previous year; …… (iii) An amount equal to one-half percent of the average of the value of investment, ;income from which does not or shalll not form part of the total income, as appearing in the balance-sheet of the assessee, on the first day and the last day of the previous year.” (Emphasis added) • Thus in light of above, Central Board of Direct Taxes, in exercise of its powers under section 119 of the Act hereby clarifies that Rule 8D read with section 14A of the Act provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. • This may be brought to the notice of all concerned. • Hindi version to follow.

Rule 2(b)(ix) of Companies (Acceptance of Deposits) Rules 1975 • “In these rules, unless the context otherwise requires, ---- (a)…. (b) “deposit” means any deposit of money with, and includes any amount borrowed by, a company, but does not include ---- …… (ix) Any amount received from a person who, at the time of receipt of the amount, was a director of the company or any amount received from a relative of a director or its member by a private company ---- Provided that the director, relative of a director or a member, as the case may be, from whom money is received, furnishes to the company at the time of giving the money, a declaration in writing to the effect that the amount is not being given out of funds acquired by him by borrowing or accepting from others;”

Practical Questions

Q.1 Can ABC Ltd accept loan from: a) Mr A, Director of the company b) Mr B, Shareholder of the company c) Mr C, Director & shareholder of the company d) Mr E, son of MD of the company

Q.2 ABC Pvt Ltd granted loan to its employee Mr A on 1.10.2013 . Subsequently, Mr A was appointed as a director of the company. Is there any contravention?

Q.3 ABC Ltd gives loan to XYX Ltd. Mr A is a director in both companies. Subsequently, XYZ Ltd is converted into private limited company. Is there any contravention of company law?

Q.4 Can ABC Ltd give corporate guarantee to bank for giving loans to its wholly owned subsidiary abroad?

Q.5 ABC Private Ltd proposes to give loan to Mr A who is sister’s husband of a director of the company. Is it permitted u/s 185 of CA 2013?

Q.6 ABC Ltd proposes to give loan to a private limited company incorporated in Germany. Mr A is a director in both companies, but no director of ABC Ltd is holding any shares of Germany company. Is it permitted u/s 185 of CA 2013?

Q.7 Mr A is a member of ABC Pvt Ltd and XYZ Pvt Ltd. XYZ Pvt Ltd gives loan to Mr X. Can ABC Pvt Ltd give guarantee for the loan?

Q.8 MrA, who is director of ABC Ltd, is also a trustee of a public charitable trust. The Trust requests the company to give some loan. Can the company give loan to the Trust?

Q.9 Paid-up capital & free reserves of ABC Ltd are to the extent of Rs.10 crores. However, ordinary resolution u/s 293(1)(d) of CA 1956 has been passed permitting borrowing upto Rs.15 crores. Accordingly, company borrowed by way of term loan of Rs.12 crores on 1.9.2013. Repayment of term loan will start from 1.4.2014. Is there any contravention?

Q.10: In the above case, the company took a second term loan of Rs.3 crores on 1.10.2013 by just passing Board resolution. Is there any contravention?

Q.11 Paid-up capital and free reserves of ABC Ltd as on 31.3.2013 were to the tune of Rs.10 crores. Profit after tax of the company for 9 months period ended 31.12.2013 was Rs.2 crores. Company wants to take term loan of Rs.12 crores in February 2014. Can it do so by passing Board resolution?

Loans under Companies Act 1956/2013