Enrooting to Alternatives…..

What happens if you are in need of money but bounded by laws & restrictions??? What would you do, if someone appreciates your work & is ready to avail funds for you to improvise & innovate your ideas….. & you cannot take it due to restrictions laid on you???  

Such are the situations that Private Companies are facing from long.  But even they have cleverly come up with ideas to make there ways... How far have they been successful? Is it right for them to take such risky steps?

Let’s check it out with respect to law………

Money is the most essential equipment for survival of any form of living. It is “the blood” for any business to exist. Every organisation to operate & obtain its objective of making long term benefits requires maximum amount of working capital.

Especially in case of companies where there are so many restrictions, often a question arises what kind of sources are available to obtain such working capital which runs into huge amount. The available sources are either obtaining-

                   1. Loans.  

                   2. Share Capital.        

The main advantages for raising money through loans when compared to issue of shares are-

ü       It is an easier method of mobilizing funds, especially during periods of credit squeeze

ü       The administrative cost of raising loans for the company is lower than that involved in the issue of shares and debentures.

ü       There is no dilution of shareholders control as the lender has no voting rights and cannot interfere with the internal management of the company.

ü       It ensures the availability of funds for a longer duration and provides flexibility to the financial structure of the company. There is no risk of over-capitalisation and the loans can be re-paid when the funds are sufficient.

To make “Maximum benefit from Minimum Resources” is a prominent objective of every organization. Such minimum resources are majorly comprised of Loans. Practically when seen it is ‘Unsecured Loans’ in picture that plays the most important role of all.

Unsecured loans can be stated as loans that can be obtained without any security against it. In today’s fast moving business world availing unsecured loans has never been a tough job. But due to prohibition laid on, private companies route it in another way.    

Law

The Companies Act restricts Private Companies from inviting and accepting deposit from public other than its members, Directors or their relatives through  section 3(1) (iii). But this is not the same case in case of Public Limited Companies. Public Limited Companies can accept deposits from public.

The term “deposit” meaning as said by The Companies Act U/s 58A is, “deposit means any deposit of money with, and includes any amount borrowed by, a company but shall not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India.”

The Companies Act lays reliance on Companies (Acceptance of Deposits) Rules 1975 for the definition of term ‘deposit’. As per the Rule 2 (b)-

“Deposits means any amount of deposit of money with, and includes any amount borrowed, by a company, but does not include any amount received from a person who, at the time of the receipt of the amount, was a director, relative of director or member.”-

-Provided that the director or 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.

[As per the Banking Regulation Act Unsecured Loan means -

“a loan not made on the security of assets the market value of which is not at any time less than the amount of such loans”.]

Ø                    PLEASE NOTE: In general, Loans and Deposits have different connotation. In case of a Loan the borrower approaches the lender for borrowing money, but in case of deposits the lender approaches the borrower to lend the money. In legal fiction, by referring to above definition loans are included & concluded as deposits by law.

Thus from the above definition [Rule 2 (b)] it is clear that the law says, unsecured loan can be availed only from Directors, relative of Directors, & Members. However, in following cases it is not treated as deposits:

-                     Any amount received from Central/State Government.

-                     Received from any Banking/Finance Company notified by Central Government.

-                     Any amount received by a company from any other company.

-                     Any amount received as security by an employee/purchasing agent/selling agent/issue of debenture.

-                     Any amount received in trust/transit.

-                     Any amount brought in by promoters in pursuance of stipulations of financial institutions.

So does this satisfy the needs of a Company? In case of non-availability of funds & tight financial situations from the mentioned sources, what does a company do?? Should it sit & think about the law or take alternatives to survive…………

Private companies & closely held Public Companies have come up with their alternatives, They have routed their funds in a very smooth manner, by treating the funds as SHARE APPLICATION MONEY even though in the real nature it is nothing less than short term funds.

Share Application Money refers to the call money raised by a Company for issuing shares & introducing Share Capital. Such money can be kept in arrears unless the Subscribed Capital is satisfied. Thus, it also acts as one of the sources to raise & utilize the fund for a short term & pay back.

Private Companies can accept ‘Share Application Money’ other than from, director, relative of director or member as against restrictions placed on acceptance of deposits.

Following Case study with an excellent example reflects certain facts of which care must be taken-

Acceptance of application money for sale of shares is considered under law, but repeated acts of deposits and withdrawal is not considered. As receipt and repayment of application money in the case of Prabhavshali Chit Fund Co. (P) Ltd. v. CIT (1994) 49 ITD 566 (Del-Trib), the Tribunal held that the submission of the amount received by way of cash was towards share application, there was no liability to return it to the applicants therefore, the contention that it cannot be categorised as a loan or a deposit cannot be accepted.

Under normal circumstances, the claim would be a reasonable proposition, but in the present circumstances, when repeatedly, the money is received and is repaid to the two directors, the claim cannot be upheld. There is no doubt that, normally amount received towards share application would not be returned, unless the amount received is in excess of the amount of share capital that is proposed to be allotted. There is also no denial that a company, after initially proposing to issue further shares, may drop the proposal. But, when this act of receiving money for further issue of shares and later dropping that idea is on more than one occasion, the same is indicative of the intention of the company that it was so brought in to tide over the tight financial situation and once the situation became favourable, it was withdrawn. This makes it in the nature of a loan or temporary accommodation only and, therefore, despite it being clothed as share application money, its true or real nature, i.e., as loan, crops out.

Conclusion

With boundaries laid down by law, Companies have improvised their knowledge & skills with the help of many sources. Enrooting to alternatives though being easier, must have a constant & careful check on it, utilizing such alternative should not be made regular in nature. Such cash flow fluctuations may lead to trouble as stated in the above case. In such cases Income Tax Act U/s Section 269 SS & 269T, restricts the acceptance/repayment of loans/deposits of Rs.20, 000/- or more aggregating in a financial year & leads to penal provisions U/s 271D as stated below:

Section 271D states “if a person takes or accepts any loan or deposit in contravention of the provisions of section 269SS, he shall be liable to pay, by way of penalty, a sum equal to amount of loan or deposit so taken or accepted.”

Source : Article by member of ICAI