Whether private limited company can grant loan to its shareholders

Whether a Private Limited Company can grant loans or advances to its shareholder(s):

A statutory analysis:

On any question regarding granting loans or advances any corporate professional would generally recall the provision of section 372A or section 293(1)(d) of the Companies Act 1956 which speak of Inter Corporate Loans or borrowing powers of the Company respectively. None of the said provision has however extended their ambit beyond the area stipulated by the statute. Specifically, Companies Act remains mute regarding granting loans to the shareholders of the companies concerned.

The present picture will however become radically different when the shareholder(s) will itself be a body corporate one. Such circumstances will positively entail the applicability of the provision of section 372A of the Companies Act 1956. If the shareholder concerned becomes a public limited company all the existing conditions and ceiling limit of (60% of paid up capital and free reserve or 100% of paid capital which ever is higher) section 372A will automatically come into play. However, as the provision of the section concerned of the Companies Act 1956 permits a free business of granting loans or advances by a private limited company regardless of any norms contained therein it seems that transaction of granting loans or advances will be impervious to any statutory bindings. Unfortunately the anomalies will arise from this misconception. It is well known that the application of section 372A or section 293(1)(d) of the Companies Act 1956 is to avoid any transaction which may later appear in detriment to the interest of the company at large by jeopardizing the interest of the shareholders. In case of a public limited company the shareholders rather public who have invested their hard earned money, have every legitimate right to vote for or against any transaction with which their right as shareholders are coupled. Any contravention of the said provision will therefore be a clear violation of statute. Unlike the public limited company, the private limited company which enjoys several privileges under the veil of Companies Act may proceed to effect such transaction easily; the decision is normally incumbent upon the board as when to, whom to and how to grant loans or advances. Moreover the provisions, if any in the Memorandum and Article of association of the company will have their specific voice either in support or in against of the proposal of granting loans or advances to the shareholders. To protect the entire interest of the minority shareholders section 397/ 398 which undo any oppression or mismanagement, will also play a vital role. Thus the same leitmotif that is the intention to protect the interest of the Company at large will prevail. If a private limited Company which has not yet booked any profit, dare to grant loans or advances to its shareholders partially, shall invite its own unrest.

To quell the disquiet and to rein such a situation Income Tax Act 1961 has stepped forward. It provides that loans or advances granted to a shareholder will be treated as “deemed dividend” only if the company concerned possesses accumulated profits( excluding capitalised profits) at the time of granting such loans or advances[section 2(22) of the I T Act 1961]. The due emphasis in this connection must be on the word ‘possesses’. If the company does not possess the accumulated profit it can not pay the same. “A company can be said to have such profits when it actually possess the amount or the amount is in its control” – R Dalmia v CIT [1982] 133 ITR 169 (Delhi). The expression of the I T Act is thus not entirely asymmetrical from the expression of the Companies Act 1956. The juxtaposition of this two apparently analogues statutory provisions ultimately keep surveillance over the financial capacity of the company to grant loans or advances to its shareholders. Because it is only the financial predicament based upon which the company’s soundness is adjudged.

To conclude Board should not proceed to embark upon such business which ultimately will put the company into trammels. Without having accumulated profit no company be it private or public limited one should incline to grant any loans or advances to its shareholders or any other organization.