The Director’s Loan is a loan related to directors that can be seen in two scenarios first one is director lend money to company and the other one is borrow money from company.
Let’s understand the first scenario :
In the companies like startups and private companies, the situations arise where immediate funds are needed. In such cases, one of the most commonly used funding mechanisms is a loan from directors, popularly known as a “Director’s Loan.”
A Director’s Loan refers to fund provided by a director to the company to support its financial requirements.
Director Lend Money to Company
- Is this lending is treated as Deposit .
Legally a director can give loan to the company, as per Section 73 of the Companies Act, 2013 read with Companies (Acceptance of Deposits) Rules, 2014 loan taken from a director shall not be treated as a deposit if a declaration in writing has been given by director stating that the amount is not being given out of borrowed funds.
The loan may be treated as a deposit if this declaration is not provided by the directors to company.
Important Condition : Director must give the loan from his own funds and not from borrowed money.
- Board Approval.
The company must pass a Board Resolution in Board Meeting as per Section 179(3) of the Companies Act, 2013 to accept the loan from director .
- Accounting Treatment
It is generally treated as Unsecured Loan Shown under Borrowings (Short-term borrowings or Long-term borrowings).
- Disclosure Regarding Related Party
Disclosure are required related to Financial statements, Notes to accounts, AOC-2 (if applicable) because director is a related party under Section 2(76).
- Interest on Director’s Loan
Interest rate on Director’s loan can be agreed mutually or director can take interest-free loan also. However excessive interest may attract tax scrutiny.
- Tax Requirements
TDS under Section 194A of Income Tax Act may apply and Interest paid to director is taxable in director’s hands.
- Precautions
- Loan agreement
- Board resolution
- Written declaration from director
- Loan shall not given from Borrowed money
- FEMA regulations and ECB norms may attracts if director is Non-Resident.
Let’s understand the second scenario :
A “Loan to Director” refers to any financial assistance provided by a company to its directors or entities in which directors have interest . This may include direct loans, advances, book debts, guarantees, or securities given by the company.
It is strictly regulated under the u/s 185 and 186 Companies Act, 2013.
While Section 185 focuses on who can receive loans, Section 186 regulates how much a company can lend or invest.
Director borrow money from company (Section 185)
- Section 185 was introduced to protect shareholders’ interests and prevent misuse of company funds by directors for personal benefit.
- A company shall not directly or indirectly give any loan (including book debt), or any guarantee or any security to :
(i) its directors of company or of its holding company,
(ii) Partners of such directors
(iii) Relatives of such directors
(iv) Firms in which such director or relative is a partner. - A company may give loan including loan represented by book or give guarantee or provide security to any person in whom director is interested subject to following 2 conditions :
(i) SR in GM has to be passed.Resolution must specify details of purpose of loan, guarantee , security for which recipient is taking loan,and
(ii) Recipient should use it for its principal business activity. - Exemption from section 185 :
(i) Company can give loan to its MD /WTD if such facility is given by company to all its employees or by passing SR in GM .
(ii) Any company which is engaged in money lending business but the interest it charges should not be less than yield of government securities of 1/3/5/10 years whichever is closest to the tenure of the loan.
(iii) Company can provide loan, guarantee, security for its wholly owned subsidiary for its principal business activity.
(iv) Company can give guarantee, security to bank / FI who provide loan to subsidiary for its principal business activity . - Fine for contravention
Company : Minimum fine 5 lac , Maximum fine 25 lac
Officer in Default : Minimum fine 5 lac , Maximum fine 25 lac or upto 6 months imprisonment or both .
Director or person receiving such loan/guarantee/security : Minimum fine 5 lac , Maximum fine 25 lac or upto 6 months imprisonment or both.
