Section 185 of Companies Act, 2013: Exemptions and Examples

“Explore Section 185 of the Companies Act, 2013, its exemptions, and practical examples. Learn when Section 185 is not applicable, including loans to managing directors, loans for employee welfare, transactions between holding companies and subsidiaries, and transactions with shareholder approval. Understand the specific conditions for private limited companies to be exempt from Section 185 and explore a detailed example illustrating the exemptions. Stay informed to ensure compliance and make informed financial decisions for your company.”

Section 185 of the Companies Act, 2013 deals with the restriction on loans and advances to directors and related entities. However, there are certain cases where Section 185 is not applicable. Here are some instances where Section 185 may not be applicable:

1. Loans to Managing or Whole-Time Directors:

• • If a loan is provided to a Managing Director or Whole-Time Director as a part of their employment contract or conditions of service, then Section 185 does not apply. These loans are considered to be in the ordinary course of business.

2. Loans to Directors for Employee Welfare:

• • If a loan is granted to a director for the purpose of meeting any expenses incurred by them for the welfare of employees, then Section 185 does not apply. This includes loans for activities such as medical, educational, or housing facilities for employees.

3. Loans to Directors by a Holding Company to its Wholly Owned Subsidiary:

• • If a loan is given by a holding company to its wholly-owned subsidiary or any guarantees or securities provided by a holding company for loans taken by its wholly-owned subsidiary, then Section 185 does not apply.

4. Loans or Guarantees with Shareholder Approval:

• • If a loan, guarantee, or security is provided by a company to its director or any other person in whom the director is interested, and such transaction is approved by a special resolution passed in a general meeting, then Section 185 does not apply.

Examples:

1. ABC Pvt. Ltd. is a company where Mr. X is a Managing Director. The company provides a loan to Mr. X as per the terms of his employment contract. Since the loan is given in the ordinary course of business, Section 185 is not applicable.

2. XYZ Pvt. Ltd. decides to provide financial assistance to its employees for purchasing homes. The company extends loans to its directors for the same purpose. As the loans are granted for employee welfare, Section 185 is not applicable in this scenario.

3. DEF Pvt. Ltd. is a holding company, and it provides a loan to its wholly-owned subsidiary, GHI Pvt. Ltd. Since the loan is given to a wholly-owned subsidiary, Section 185 does not apply.

4. PQR Pvt. Ltd. wants to provide a loan to its director, Mr. Y. However, before granting the loan, the company obtains approval through a special resolution passed in a general meeting. In this case, since the loan is approved by the shareholders, Section 185 is not applicable.

Also, it important to note that Section 185 is not applicable only to a Private Limited Company if the following conditions are fulfilled:

As per the exemption notification dated 5th June 2015, Section 185 of the Companies Act, 2013 shall not apply to a private company if it meets the following conditions:

a) In whose share capital no other body corporate has invested any money:

• This means that the private company should not have any investments in its share capital by other corporate entities.

b) The borrowing of such company from banks or financial institutions or any body corporate is less than twice its paid-up share capital or fifty crore rupees, whichever is lower:

• This condition states that the total borrowing of the private company, including loans from banks, financial institutions, or other corporate entities, should be less than twice its paid-up share capital or fifty crore rupees, whichever is lower.

c) Such a company has no default in repayment of such borrowing subsisting at the time of making the transaction under this section:

• This condition ensures that the private company has not defaulted in the repayment of its borrowings at the time of entering into any transaction falling under Section 185.

Here’s an example to illustrate the exemptions:

Example: XYZ Pvt. Ltd. is a private company engaged in the manufacturing of automobile components. Let’s assume the following details:

• Paid-up share capital of XYZ Pvt. Ltd.: Rs. 20 crore
• Borrowing from banks and financial institutions: Rs. 30 crore
• Borrowing from other corporate entities: None
• Default in repayment: No

In this scenario, XYZ Pvt. Ltd. would be eligible for the exemption under Section 185 based on the following analysis:

a) Share capital investment by other corporate entities: As per the condition, no other body corporate has invested in the share capital of XYZ Pvt. Ltd., which satisfies condition (a).

b) Borrowings: The total borrowing of XYZ Pvt. Ltd. from banks and financial institutions is Rs. 30 crore. Since this amount is less than twice the paid-up share capital (2 * Rs. 20 crore = Rs. 40 crore), it satisfies condition (b).

c) Default in repayment: There is no default in repayment of borrowings by XYZ Pvt. Ltd. at the time of the transaction. Hence, it satisfies condition (c).

As a result, XYZ Pvt. Ltd. can avail the exemption under Section 185 for transactions that meet these conditions.

It’s important to note that the above example is for illustrative purposes, and the specific circumstances of each company may vary. It’s advisable to consult legal professionals or company secretaries to ensure accurate interpretation and compliance with the provisions of Section 185 and the exemption notification.

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Author is A Practicing Chartered Accountant with over 5 years of rich experience in Company Law, Audits, Accounts & taxation.  She is keen in streamlining business accounts of the Company and provide Business advisory services She can be connected on sweta@caswetamakwana.com or on 9819244185