This article is written by Anupriya C. an intern under Legal Vidhiya.
Introduction
“Money has never changed anyone. It just magnifies who they are”[1] In the corporate industry the give-and-take interrelation of loans and guarantees simply can be understood with inter-Corporate loans[2]. This type of loan is a non-traditional channel of external financing through which corporate entities with surplus funds extend loans to others. If it’s simply put it is when a company invests in another company which is known as inter-corporate investments. This term of inter-corporate loan and investment is found under section 186 of the Companies Act, 2013.
[3]The companies that participate in these fund transfers also extend funds to separate, non-group, or stand-alone businesses. The companies engaged in these fund transfers may or may not be a part of the same business group or conglomerate. This research will examine the provisions of section 186 of the act and also will discuss about corporate governance in India.
Background
Inter-corporate loans are administered under the Indian Investment laws of the country.
Section 186 of the companies act provides for the loans and investments that could be made by the company. It states that a company could make investments through more than two layers of investment companies.
Let’s briefly understand every subsection of 186 to get a better knowledge of the topic
Section 186(1)
The very reason behind comprehending this section was to keep checks and balances of giving loans and making investments by one company to another. There was a need to protect the interest of stakeholders and owners in the market while also preventing excessive loan dilution of shares.
[4]Exception
1. A company in India may purchase shares and invest in more than two layers in an investment company established outside of India if the domestic laws allow for such additional layers of investment. This is the first exception to the two layers rule. Given that the investment firm is incorporated and conducts business outside of India, this investment shall not be subject to the two-layer restriction of Indian law. Another situation in which the two-layer restriction does not apply is when the presence of such extra investment subsidiary layers is required for an investment company to comply with any law or regulation.
Section 186 (2)
This clause talks about the limitations and sectoral cap ( relates to the maximum amount that can be invested in capital instruments or LLP capital on a repatriation basis by residents of countries other than India.) put on these inter-corporate loans and investments.
The reason behind adding limits in these kinds was to maintain a balance on investments made or loans given.
Loans, guarantees, and investments made directly or indirectly to any person, business, or other entity corporate are prohibited under Section 186 (2). All types of capital expenditures, including loans, investments, guarantees, and the purchase of shares and stocks, are subject to these restrictions.
Accordingly, loans or investments of any kind must not be made by the requirements of Section 186 (2) of the Companies Act of 2013:
- More than 60% of its total Paid-Up Share Capital, Free Reserves, and Securities Premium Account,
- 100% of its Paid-Up Share Capital, Free Reserves, and Securities Premium Account.
When making investments or extending loans, the investing business may select whichever of the two alternative limits it prefers. It is noteworthy that investment firms are subject to the two layers of the investment rule. However, investments can also be made in body corporations through the purchase or subscription of shares and other assets. The two layers rule is applied to two layers of such investment companies, and the company through which this investment may pass to a body corporate must be an investment company.
Listing some exceptions concerning inter-corporate loans
[5]Under this provision, inter- corporate loans won’t be applied
- In this a banking company, house financing company or insurance company
- a business created to finance industrial companies or provide infrastructure services.
- Most importantly a registered non-banking finance company focuses mainly on stock acquisition.
Restrictions on inter-corporate loans
- A company may also enter into joint ventures with its wholly-owned subsidiary and purchase securities from that subsidiary’s parent company above the set limit, as well as provide loans and guarantees to that subsidiary.
- A business covered by this class of companies and registered under Section 12 of the Securities and Exchange Board of India Act, 1992 (SEBI), may accept inter-corporate loans or deposits over the allowed amount.
[6]How to issue inter-corporate Loans?
Here are some procedures that need to be followed:
1. After providing notices and proposals for granting an inter-corporate loan, guarantee, or security within the permitted maximum specified under Section 186(2) of the Act, hold a Board of Directors meeting.
2. Pass a motion authorizing the granting of the inter-corporate loan, guarantee, or security at the Board of Directors meeting with the approval of all directors present.
3. The Board of Directors must determine whether the business currently has a loan from a publicly traded financial organization. If there is already a loan from a state financial institution, that financial institution must first give its consent before making another loan to another company.
4. After determining the amount and fund of the loan, the Board of Directors must authorize one director or any other person to request approval of the inter-corporate loan to be given to other body corporates.
5. The Board of Directors must convene a general meeting with the shareholders after giving proper notices and pass a special resolution in the general meeting for the granting of such inter-corporate loans, guarantees, or securities when the company grants loans, guarantees, or securities above the prescribed limit provided under Section 186(2) of the Act.
6. Within 30 days of the resolution’s passage, submit a duplicate of the special resolution in Form MGT-14 [7]to the Registrar of Companies along with the necessary paperwork and payment.
7. After giving the loan, guarantee, security, or making an acquisition, keep the registers in Form MBP-2[8].
8. Make documents in the register for each loan, guarantee, security, or purchase you make.
9. The register must be kept by the business at its registered office and be accessible for inspection. After paying the required fees, business members may obtain copies and extracts from the register.
10. The business is required to include information about the granted loans, guarantees, securities, or investments in the financial statements, along with the intended use of the loan, guarantee, or security by the recipient.
11. Look closely at the company’s past interest or deposit repayment.
Fine and penalty for contravention of the companies act,2013
If any company is in default in complying with provisions of the company act 2013 then the company will be liable to pay an estimation penalty from 25k to 5lakhs and every officer who is in default will be liable for 50k.
Disclosure of particulars of the loan in your financial statement
According to Section 186(4) of the Companies Act of 2013, when a company has made an inter-corporate loan, it is required to reveal the following information to the members in the financial statement.
A. Amount of loan that has been provided
B. The investment made and the guarantee given to the company
C. Why did you (the company) provide the loan
D. The source of funding
E. The particulars of the body corporate interested in making such loans.
Covid-19 crisis
the pandemic disrupted the ecosystem of the corporate which led to reducing bank lending rates up to zero percent to maintain order to preempt a potential liquid crisis in the entire world. While some borrowers anticipated falling behind on their debt payments, others are considering the advantages and disadvantages of refinancing their debts to benefit from reduced interest rates.
The crisis led to affect the interest rate in 2 ways
First, some taxpayers who previously chose to use the Applicable Federal Rate (AFR), a safe haven rate under Treasury Regulation section 1.482-2, may find the market interest rates even lower in light of the meager market interest rates.
Second, there there were fewer market benchmarks accessible for analyzing inter-company loan agreements due to decreased levels of third-party lending as a result of anticipated liquidity crises and lenders’ concerns regarding the ability of loan applicants to handle debt payments.
Corporate governance in India
It is a mechanism based on principles and statues by which companies can be under the vigilance of the authorized entity . The governance of corporate ensures that is controlled in a way that it can achieve the goals which also include benefits of the stakeholders of the company. The governance of a corporate body is maintained and conducted by the boards of directors and the concerned committees for the benefits of employees,customers and especially the stakeholders. This is all about balancing and maintaining economic and social objectives of corporate industry.
Importance of Corporate Governance in Asia
This term gained attention in recent years due to Asian financial crisis.Asia is a tremendously diverse region in terms of institutional structures and economic levels of development. India and Indonesia have per capita incomes of around $1000, whereas Hong Kong and Singapore have per capita incomes of over $30,000. There are certain similarities among the economies, most notably the presence of family ownership and transactional relationships (Rajan and Zingales 1998). The central issue of our survey is determined by this nexus, which also acts as the institutional framework for the majority of analyses. The research on corporate governance in Asia demonstrates that the combination of ownership structure and the system of property rights (law and enforcement) substantially defines the incentive, policy, and output of managers and their companies. While Asia has certain unique corporate governance problems, there are also numerous concerns with corporate governance in Asia that apply to other nations, most notably the importance of family ownership concentration and the level of minority rights protection.
Asia’s stock market is expanding quickly to become the biggest in the world. Asia now accounts for more than half of all listed firms worldwide. The size of this transformation is changing the characteristics of the global financial market, which is also integrating more. As a result, the OECD closely monitors these developments through a comprehensive programme that includes comparative data and analysis across a variety of capital market issues, including primary equity markets, corporate bonds, capital market structures, and the activities of financial service providers. The OECD-Asia programme also hosts an ongoing multilateral dialogue to identify best practices, boost private sector competitiveness, and support a seamless integration of Asia’s expanding capital markets into the global economy. This dialogue is based on the G20/OECD Principles of Corporate Governance, which are endorsed by all economies hosting Asia’s largest stock markets.[9]
Case laws related to inter-corporate loans
[10]Jindal Vijayanagar Steel Ltd. vs Assistant Commissioner Of … on 12 November 2002
Facts of the case
1. According to the Certificate of Incorporation issued by the Registrar of Companies, Karnataka, the appellant was incorporated as a Public Ltd. Company on March 15, 1994.
2. The main work of the company was to set up iron and steel-making facilities and continuous casting and hot and cold rolling mill plants for producing all kinds of metals.
3. The term “incidental” or “ancillary” refers to a wide range of activities, including the import and export of all kinds of goods and services, acting as an engineering consultant, building real estate, lending money, making money advances, purchasing and selling securities, offering guarantees for business transactions, investing surplus funds, drawing, accepting, and discounting bills, among many other things. It suffices to mention that it encompasses a wide range of activities, from manufacturing to financing loans and advances.
4. After which the company complying with statutory formalities obtained the certificate of commencement of business under the companies act on the 8th of July 1997.
5. Company started raising share capital, borrowing in the form of debentures on private placements, and also raising inter-corporate loans from various entities.
6. Before doing so, the business approved a resolution under Section 293(1)(a) of the Companies Act authorizing the Board of Directors to borrow a sum totaling Rs. 3300 crores at its Extraordinary General Meeting on September 15, 1994.
7. Following that, the company authorized the Managing Director to advance loans on such terms and conditions as would be in the best interest of the company, up to a maximum of Rs. 5 crores per party (or, in certain specific cases, up to a specific limit below Rs. 114 lakhs). As a result, massive transactions worth hundreds of crores of rupees were carried out throughout the previous year. Bill discounting, letters of credit-based structured financing, the acquisition and selling of bonds, government securities, and Unit Trust of India units, equipment leasing, inter-corporate and personal loans, bank deposits, the company advances to staff, etc. were all part of the transactions. 3.2 Since the income was offset against capital issue costs, no profit and loss account was created.
Arguments
We are not inclined to agree that expenses that can be attributed to excess share application money should be allowed as revenue expenses. So long as the expenses were incurred on the issue of shares, whether shares are allotted or not against the share application, will retain their character as ‘share issue expenses’ only and will be consequently treated as ‘capital expenditure. Thus no part of share issue expenses is allowable.
Held
We based our decision on the Supreme Court’s ruling[11] in which the Apex Court outlined the different treatment that should be given to expenses incurred before and after the start of a business. Since the company has already started in this instance, we have no hesitation in approving the expense expended. Therefore, after subtracting the Rs. 6,91,701 spent on a donation that is not permitted, we hold that the expenditure of Rs. 15,43,40,694 made by the corporate treasury division is an authorized expense. We hold that the cost of Rs. 10,77,53,775 incurred on the issue of the non-convertible component of the debentures is admissible as revenue expenditure in computing the appellant’s income, basing our conclusion on the Supreme Court’s ruling in the India Cements Ltd. S case (supra) and the CBDT circular extracted above. As a result, the Assessing Officer will classify all of the Rs. 11.07 crore in receipts as business income and deduct from that amount the Rs. 15,43,40,694 in corporate treasury division expenses (exclusive of donations) and the Rs. 10,77,53,775 in debenture issue expenses described above. Additionally, the Assessing Officer must grant consequential relief for interest assessed under Section 23 4B of the Act.
Suggestions related to start up
[12]Giving loans is a risky task in the corporate industry as it’s dependable on how the economy is working and changes in the economy.
Advantages
- A easy process is typically done through third-party software
- Investment capital raised by the parent company can be directly given to the subsidiary
- Depending upon the company and how beneficial it is in the long run banks or outsourced companies can cut off a little portion of the loan.
Disadvantages
- Tax issues
- Inability to pay if the market is crashing
- Broken terms and conditions if a borrower does not abide by the law, this may result in an IRS audit, financial burden on the issuer, or a need for litigation between the two businesses.
Conclusion
One of the most essential elements for operating any firm is money. Businesses have access to loans, share capital and other types of funding. Loans are the main source of finance for the majority of enterprises. One of the best ways for companies to raise money today is through an inter-corporate loan. All of a company’s capital demands and requirements are met by the inter-corporate loan. A firm may only make an inter-corporate loan to another company or body corporate with the board of directors and shareholders’ consent.
[1] Baylor Barbee
[2] See.Inter-corporate loans: the Indian experience by Anupam.N
[3] Section 186 of companies act, pg no. 115
[4] https://cleartax.in/s/inter-corporate-loans-section-186 last seen on 05/04/2023
[5] https://cleartax.in/s/inter-corporate-loans-section-186 last seen 06/06/2023
[6] https://taxguru.in/company-law/inter-corporate-loans-investments-section-186.html last seen 06/04/2023
[7] Form No. MGT-14. Filing of Resolutions and agreements to the Registrar. [Pursuant to 117(1) of The Companies Act, 2013 and Rule 24 of The Companies (Management and Administration) Rules, 2014]
[8] A record of all loans, guarantees, security placements, and acquisitions the business has made.
[9] https://www.oecd.org/Last seen on 06/04/2023
[10] https://indiankanoon.org/doc/1790337/ last seen on 06/04/2023
[11] Tuticorin Alkali Chemicals & Fertilizers Ltd.
[12] [12] https://www.slideshare.net/prithvighag/inter-corporate-deposits-24373239 last seen on 06/04/2023
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