Revisiting the Recital Clause in an ICD Document

A typical recital clause of an inter-corporate deposit document would read like this:

WHEREAS

A.     The borrower is engaged in the business of inter alia, trading goods and products, selling agents of petroleum and petroleum products as authorized by its object clause of its memorandum of association.

B.     The borrower urgently requires a sum of Rupees three crores only for its business purposes and has approached the lender for an inter-corporate deposit facility of a principal amount of Rupees three crores only from the lender which the lender has agreed to.

C.     The borrower and lender thus desire to record such agreement for the grant of the facility by the lender to the borrower upon the terms and subject to the conditions as stated hereinafter and on the basis of the representations and warranties, covenants and undertakings made by the parties to each other and recorded herein.

In the above recital we note the following:

(i)                The borrower is in need of money.

(ii)              The borrower, thus, approaches the lender with a proposal to deposit the requisite sum with it.

(iii)            The lender deposits the sum with the borrower at the agreed terms and conditions.

When would we like to make a deposit of a sum with a bank or any other entity and what do we do then? We would like to make deposit of a sum with a bank etc. when we have extra fund. In such an event, we would go to a bank etc. and make a request to them to accept the sum as deposit for agreed terms and conditions, which will invariably be the standard terms and conditions applicable to all without any concessions.

In Pennwalt India Ltd and Others v. ROC, Maharashtra and Others ((1987) 62 Comp Cas 112) the appellant company had deposited amount exceeding 30% of its subscribed capital and free reserves with various public companies without taking prior approval of the shareholders by passing a special resolution under section 370(1)(a) of the Companies Act, 1956 (“the Act”). In the above case the Bombay High Court held that the dividing line between a loan and a deposit is undoubtedly thin: the two, however, are not synonymous. It may not be possible to interchange the terms “loan” and “deposit” under the Act unless there is an express provision to that effect or the context makes it clear that the terms are interchangeable. Both in the case of a loan and a deposit there is a relationship of a debtor and a creditor between the party giving money and the party receiving money.  But in case of a deposit, the delivery of money is usually at the instance of the giver and it is for the benefit of the person who deposits the money. In the case of a loan, however, it is the borrower at whose instance and for whose needs the money is advanced. Ordinarily, though not always, in the case of a deposit, it is the depositor who is the prime mover while in the case of a loan, it is the borrower who is the prime mover. The other more important distinction is in relation to the obligation to return the amount so received. In the case of a deposit which is payable on demand, the deposit would become payable when a demand is made. In the case of a loan, however, the obligation to repay the amount arises immediately on the receipt of the loan. It is possible that in the case of deposits which are for a fixed period or loans which are for a fixed period, the point of repayment may arise in a different manner. But, by and large, the transaction of a loan and the transaction of making deposit are not always considered identical. The nature of the two is somewhat different and that is the reason why a distinction is made between the two for the purpose of calculating the period of limitation.

On the basis of the above ratio, the High Court held, allowing the appeal, that as non-compliance section 370 of the Act involved penal consequences, it could not be given an interpretation wider than that warranted by the actual words. Without any provision to that effect, the word “loan” as used in section 370 could not be given a wider interpretation so as to include deposits.

The present provision in the Act dealing with inter-corporate loans and investments is section 372A, which was inserted by the Companies (Amendment) Act, 1999. The present provision is similarly worded and requires that prior approval of the shareholders shall be obtained by passing a special resolution, in the event a company makes any “loan” to any other body corporate exceeding 60% of its paid-up share capital and free reserves. A non-compliance of the section is punishable with imprisonment and fine. Therefore, the ratio of the Bombay High Court’s judgment in Pennwalt India still holds the ground.

Therefore, making of inter-corporate deposits is still out of the purview of section 372A of the Act which requires special resolution to be obtained by the company in certain circumstances. However, by way of abundant caution, it is suggested that the recital and other operative clauses of an inter-corporate deposit agreement should be drafted in a manner to achieve the above legal distinction between loan and deposit, e.g., “…the lender is interested in placing its funds as deposits with the borrower (for whatever reason) to which the borrower has agreed (because it needs the funds for its business etc.)…”

However, the above may not give any respite from tax liability on interest earned by the company on the inter-corporate deposits. In Bajaj Auto Holdings Ltd v. Dy. CIT ((2006) 281 ITR (AT) 154 (Mumbai)) the Mumbai bench of the Income-tax Appellate Tribunal held that the scope of section 2(7) of the Interest-tax Act, 1974 is enlarged so as to include interest not only on loans, but also advances. There is no specific provision in the Interest-tax Act, which grants exemption in respect of interest on inter-corporate deposits. Thus it was held that interest-tax is leviable on the interest income earned by the company on inter-corporate deposits.

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