"InsightStack Pvt Ltd" has been profitable for two years. Cash in the bank: ₹2.4 crore. Sandeep wants to buy a 3BHK in Pune — ₹1.6 crore property, needs ₹40 lakh as down payment. Indian banks would lend the rest at 9.5%.
Sandeep thinks: "Why pay bank interest? I'll take ₹40L from my own company. Pay myself back over 5 years from salary. Effectively a 0% loan."
His CA, slightly worried, lets him do it but asks him to come in for a year-end review. There she pulls out three sections of law that Sandeep didn't know existed. By the end of the conversation, he's negotiating with HDFC for an actual home loan.
- Section 185 Companies Act prohibits a Pvt Ltd / Public Ltd from giving loans to its directors and their relatives — with narrow exceptions. Penalty: company fine ₹5L-25L + director fine ₹5L-25L + up to 6 months imprisonment.
- Section 2(22)(e) Income Tax treats any loan from a closely-held company to a shareholder with ≥10% beneficial interest as a "deemed dividend" — taxed at the shareholder's slab rate. Sandeep's ₹40L becomes additional income of ₹40L → ~₹12L extra tax.
- DPT-3 reports loans FROM directors / shareholders TO the company. Loans the other way are subject to Sec 185, not DPT-3.
- Legitimate alternatives: (a) salary + bonus, (b) declared dividend, (c) interest-bearing arm's-length loan with proper resolutions if you fall into a Sec 185 exception (very narrow). For a founder with 70% shareholding, the salary + dividend mix is the only realistic path.
- The structurally correct answer: declare a special dividend. Costs the company nothing extra, costs Sandeep the same slab tax as deemed dividend, but with proper paperwork and no Sec 185 exposure.
Sec 185 Companies Act — the blanket prohibition
Section 185 of the Companies Act 2013 says: "No company shall, directly or indirectly, advance any loan to any of its directors or to any other person in whom the director is interested."
"Person in whom the director is interested" is defined broadly — it includes the director's relatives, partners, sole proprietorships, and other companies where the director is also a director / shareholder. The net is wide.
Exceptions (narrow):
- Loan to a managing/whole-time director as part of "conditions of service" extended to all employees, OR loans under an approved scheme.
- Loan to a wholly-owned subsidiary (group lending).
- Loan in the ordinary course of business if the lending of money is part of the company's business (NBFCs).
- Loan to other body corporates is covered by Sec 186 (separate restrictions, but allowed with shareholder approval).
For Sandeep — a founder/director taking ₹40L for personal purposes — none of these exceptions apply. The loan is illegal under Sec 185.
Penalty: company fine ₹5L–₹25L + director fine ₹5L–₹25L + imprisonment up to 6 months OR both. The director who signed the cheque is personally liable. The "officer in default" of an unlawful loan is criminally exposed.
Whole-time directors can receive advances against future salary — this is a contractual entitlement extended to other employees. But the "advance" must be reasonable (a month or two of salary, not 8 years' worth), structured at standard employee terms, and not a disguised personal loan. ₹40L against a ₹5L/month MD salary = 8 months, plausibly OK. ₹40L against ₹50k/month = ridiculous, will be characterised as Sec 185 violation.
Sec 2(22)(e) Income Tax — the deemed dividend
Section 2(22)(e) is the Income Tax counterpart. It applies to "closely-held companies" (broadly: companies in which the public is not substantially interested — which covers basically every Pvt Ltd and even unlisted public companies):
Any payment by such a company by way of loan or advance to a shareholder who holds ≥10% beneficial interest (or to a concern in which such shareholder has substantial interest) is treated as "dividend" to the extent of the company's accumulated profits.
For Sandeep with 70% shareholding:
- ₹40L loan from closely-held InsightStack → deemed dividend in his hands.
- Taxed at his individual slab rate (post-DDT-abolition, dividends are slab-rate in shareholder's hands).
- At top slab + surcharge + cess, effective rate ~35-39% → tax ~₹14-16L.
- The company gets no deduction for it (it's a balance-sheet item, not P&L).
- If Sandeep later repays the "loan", he does NOT get the tax back. The deemed dividend was triggered at advance; repayment is just a normal repayment.
This is the real economic cost. The Companies Act penalty might be settled with paperwork and a fine; the Income Tax deemed-dividend tax is permanent and large.
The three-section overlap, side by side
Sec 185 (Co Act)
Prohibits
The act of giving the loan is itself illegal (with narrow exceptions). Fine + imprisonment exposure for the company + officer. This is the criminal-law layer.
Sec 2(22)(e) (IT)
Recharacterises
Even if loan was technically legal, IT recharacterises it as a deemed dividend to the borrowing shareholder. Slab-rate tax in their hands. This is the tax layer.
DPT-3 (Co Act)
Reports incoming
Annual return of deposits / loans received by the company — including from directors / shareholders / related parties. Doesn't cover loans TO directors (those are Sec 185 territory). Due 30 June each year.
The three legitimate alternatives
Highest-leverage tool. As Managing Director, Sandeep can draw a high salary deductible at company level (saves company 22-25% tax) and taxed at his slab rate. For a profitable Pvt Ltd, salary + bonus is the cleanest personal cash flow. Limit: salary must be "reasonable" — Sec 198 + Schedule V Companies Act caps managerial remuneration.
Since FY 20-21, DDT was abolished. Company pays dividend out of post-tax profit (no further company tax on the dividend itself). Shareholder receives the dividend and pays at slab rate. For Sandeep — same tax as deemed dividend would have been, but: legal, documented, no Sec 185 risk, no MCA red-flag.
Take a personal home loan from a bank (₹40L). Sandeep's home becomes the security. EMI is tax-deductible up to limits under Sec 24(b) (interest) and 80C (principal). Interest cost is real but with full tax shield. Plus: clean credit footprint, no company-law issue, doesn't deplete company cash.
Sandeep's actual best path
For a ₹40L need with a profitable closely-held Pvt Ltd:
- Declare a special dividend of ₹40L (assuming company has the profits and cash to do so). Board resolution. Pay shareholder. Pay TDS under Sec 194 (10% if dividend > ₹10k).
- Sandeep's tax on the ₹40L dividend at top slab ≈ ₹14L (similar to the deemed-dividend outcome but properly structured).
- OR: Take a bank home loan at 8.5-9.5%, deductible under Sec 24(b) up to ₹2L/year + 80C ₹1.5L principal. Annual tax-shield ≈ ₹1L. Effective interest cost ~6-7%. Keep company cash for working capital.
- OR: A mix — special dividend for the down payment + bank loan for the rest.
The "loan from own company" route is dominated on every dimension by these alternatives — legal, tax, and reputational. The only reason it persists in practice is that founders don't know about Sec 185 / 2(22)(e) until their CA explains.
What if the loan has already happened — how to unwind
- Don't panic, but act in the same FY if possible. Get the loan reclassified.
- Option A — Repay immediately. If Sandeep can repay within the same FY (before 31 March), some High Courts have held that the deemed-dividend characterisation may not stand if the loan was fully reversed before year-end. Risky, contested, but a real defence path.
- Option B — Reclassify as a dividend. Board resolution converting the "advance" to a declared dividend. Pay TDS under Sec 194. The Sec 185 issue is also addressed (it's now a dividend, not a loan).
- Option C — Reclassify as advance against salary. If structurally defensible (Sandeep is MD with sufficient prospective salary to absorb the advance), document it as such. Set up monthly repayment via salary deduction.
- Disclose proactively in next AOC-4 / MGT-7 / Tax Audit Form 3CD. Hidden disclosures discovered later trigger penalty + interest. Proactive disclosure is much cheaper.
What DPT-3 actually captures (the other direction)
Form DPT-3 is the "Return of Deposits". It captures money the company has received from various sources — but NOT all of these are technically "deposits" under the Companies Act.
- Loans from directors (acknowledged as not-deposit if accompanied by declaration that funds aren't borrowed by director from others).
- Loans from shareholders / relatives of directors.
- Trade advances received from customers.
- Inter-corporate deposits.
- Convertible notes / SAFE arrangements (relevant for startups).
Even if the company has zero deposits, file a Nil DPT-3 by 30 June every year. Penalty for missing: ₹5,000 + ₹500/day. See our year-1 compliance calendar for full ROC filing list.
The funny historical wrinkle
Pre-1985, loans from companies to directors were common, especially in family businesses. The 1985 amendments to the Companies Act tightened this; the 2013 Act made it a near-blanket prohibition with limited carve-outs. In parallel, Income Tax law added Sec 2(22)(e) (the deemed dividend clause was in the older 1922 Act too, but the 1961 Act formalised it).
The two laws layered on top of each other create the paradox: you can be both criminally liable under Sec 185 AND taxed under Sec 2(22)(e). The company gets prosecuted; the shareholder gets taxed. Neither escapes via the other. For founders of closely-held companies, this is the single most important "do not do this" lesson — and yet probably the most-violated rule in Indian SME practice.
Quick answers
Sec 2(22)(e) (deemed dividend) requires ≥10% beneficial interest — below that, it doesn't trigger. But Sec 185 (Companies Act prohibition) applies to ALL directors regardless of shareholding. So a 5% director still cannot legally take a loan from the company.
If she's a "relative" of the director and "person in whom director is interested" under Sec 185 — same restriction applies. Cannot. Also: if she's also a shareholder, additional Sec 2(22)(e) deemed-dividend exposure if she's ≥10%.
Yes — this is allowed and routine. Loans from directors / shareholders / relatives TO the company. Subject to documentation (loan agreement, declaration that not borrowed) and disclosure in DPT-3. Often used as bridge funding in early stages.
Sec 186 restricts a company from giving loans / guarantees / investing in other body corporates beyond certain limits without special resolution. Different from Sec 185. Mostly relevant for inter-corporate transactions, not personal loans to founders.
For founders who are already substantial shareholders, ESOPs are usually structural (giving employees a piece). For founder cash flow, salary + dividend is the cleaner tool. See our ESOP tax guide for employee-side mechanics.
When you might want help
Three situations: (1) You've already taken a "loan" from your own company and want to unwind it cleanly. (2) Planning to take out cash for a personal purchase / property — we'll structure the cleanest legal/tax mix of salary + dividend + bank loan. (3) Annual Sec 185 / 186 compliance review for a multi-entity family group.
Loan from your own Pvt Ltd?
Sec 185 / 2(22)(e) / DPT-3 review + restructuring + clean alternatives. We design the founder cash-flow setup correctly. Fixed scope.
"Sandeep" and the numbers shown are composite illustrations. Your specific exposure depends on shareholding %, company surplus, and structure.