Security deposit

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

20 June 2014 Company A & B are pvt. Ltd companies with common director. A is providing certain services to B for which consideration is paid to A at market rates. For the performance of contractual obligations, A is required to provide certain amount to B as interest free refundable security deposit.

Security deposit does not fall within the ambit of "deposit" as per Acceptance of deposit Rules 2014.

Deposit is defined to include Loan but there is no definition given for Loan.

In the given scenario, whether payment of security deposit will attract provision of section 185 which prohibits loan to be given to the director or to a concern in which director is interested?

Whether, section 186(7) relating to minimum interest rate will be applicable to security deposit also?

CA. Amit G. Chandani

CA. Amit G. Chandani (Expert)
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21 June 2014 If it is in the nature of deposit, section 185 is not applicable.
Only section 186 will be applicable in this case.
Loan include deposit – that was the position under section 372A of CA, 1956 by virtue of Explanation therein. We don’t find such explanation in Section 186 of CA, 2013.

Querist : Anonymous

Querist : Anonymous (Querist)

23 June 2014 Thanks. If 186 is applied, then there has to be interest payout as per 186(7). In that scenario, there would be additional consideration flowing out to the service provider i.e. interest + service income which is already at market rates. Any views on this?

Asha Kanta Sharma online

Asha Kanta Sharma online

(Expert)
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23 July 2025 This is a nuanced situation involving **inter-corporate security deposits** between **private companies with common directors** under the **Companies Act, 2013**. Here's a breakdown addressing your concerns with regard to **Section 185 and Section 186**, especially **Section 186(7)** on interest payment.

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### 🔹 **Facts Recap**:

* Company A provides services to Company B (both private companies, common director).
* Company A gives **interest-free refundable security deposit** to Company B as per the service contract.
* Services are at **market rate**, so no underpricing concern.
* The **deposit is not a “deposit”** as per Companies (Acceptance of Deposit) Rules, 2014.
* Doubt: Whether this security deposit is considered a **loan**, thereby attracting:

* **Section 185** (loan to director/related concern)
* **Section 186(7)** (requirement to charge interest)

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### 🔹 1. **Applicability of Section 185 (Loan to Directors, etc.)**

**Section 185(1)** prohibits a company from advancing *any loan* to:

* Any **director**, or
* Any **other person in whom the director is interested** (includes other body corporates where the director is a director/member).

✅ **Your case**: Company A gives interest-free deposit to Company B, where a common director exists → this makes **Company B** a “person in whom the director is interested”.

🟨 **BUT**: If the **security deposit is strictly in the nature of a commercial arrangement** (i.e., a performance guarantee or earnest money under contract), and **not in substance a loan**, **Section 185 may not apply**.

🔍 **Case Reference / Practical View**:

* If it can be shown that the deposit is purely contractual and **non-financial in nature (i.e., not a financial assistance)**, and returned on performance — **Section 185 may not be attracted**.
* Key is the **substance over form** — if there’s no financial accommodation intent, and it’s a business deposit, **it may be exempt**.

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### 🔹 2. **Applicability of Section 186(7) – Interest on Loan**

Section 186(7):

> “No company shall give any loan to any person or other body corporate at a rate of interest lower than the prevailing yield of 1 year, 3 year, 5 year or 10 year Government security closest to the loan’s tenor.”

✅ If the **security deposit is classified as a loan**, even between group companies, **Section 186(7)** mandates **minimum interest rate**.

🔍 **But, the term “loan” is not defined under the Act**.

📌 **What matters**:

* If the security deposit is genuinely **not a financial assistance**, i.e., it is **returned after contract completion**, is **not available for free usage**, and has **no financing motive**, it may **not be a loan**, and Section 186(7) may not apply.

📚 **Judicial/Expert View**:

* Courts and MCA have interpreted that **contractual deposits (performance security, retention money, margin)** are **not necessarily loans**, if not in the nature of **financial accommodation**.
* **No interest required** if it's **not a loan** under Section 186.

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### 🔹 ✅ Recommended Action:

To **avoid applicability** of Sections 185 and 186:

1. **Clearly draft the agreement** to show the deposit is for **contractual performance/security**, not a financial loan.
2. Keep it **refundable**, **non-interest bearing**, **tied to contract milestones**.
3. Ensure it is **not used by recipient for financing** — i.e., not parked as a general-purpose fund.
4. Ensure **no clause allows free usage** by recipient company.

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### 🔚 **Conclusion**:

* **Section 185** *may not apply* if the deposit is **contractual and not financial assistance**.
* **Section 186(7)** *may not apply* if the deposit is **not in the nature of loan**.
* **Documentary evidence and intent** are key — if the transaction appears as financial accommodation, both sections can apply.

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Let me know if you'd like a sample clause or board resolution format for this type of deposit to ensure compliance.

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