Money the director owes the company: is it actually allowed?

Hook

Open your company's books and find the line called director's current account. Almost every SME has one. I will ask you a single question: is that figure on the debit side, or on the credit side? It is fine if you cannot answer. But you need to know this — the two directions are two completely different laws. One direction, and nothing happens at all. The other direction, and it is a fine of up to three million ringgit, or five years in prison.

First, get the direction straight

Money goes from your pocket into the company. Working capital is short and the boss puts his own money in. It is recorded on the credit side — the company owes you. That is a liability. The law is not interested in you. It is perfectly normal and it happens every day. Money comes out of the company and into your pocket. The boss puts personal spending on the company's money, or takes company money to buy something private. It is recorded on the debit side — you owe the company. From that second on, section 224 of the Companies Act 2016 is watching you. The same account name, two directions, and the law treats them worlds apart.

What section 224 says

The provision is short — two sentences. First, a company must not lend money to a director. Second, a company must not give a guarantee or provide security for a director's personal loan. The second sentence is the one most people trip over. The boss will say: "I did not take the company's money at all, I only put up the company's property as security so that I could borrow for myself." Just as unlawful. You did not take the company's cash, but you pledged the company's assets — the provision says so in plain words. There is also a question of scope: it is not only the directors of your own company. The provision covers this company and the directors of related companies — the holding company, subsidiaries, sister companies under the same holding company — the directors of those companies count as well.

Four exceptions, and the twist

The provision gives four exceptions. The first, and the most important: an exempt private company. The second: money given to a director that is spent on the company's behalf, or that lets him carry out his duties. The third: a director employed full time by the company, buying a house. The fourth: a loan under an employee loan scheme the company has already approved. The middle two — spending on the company's behalf, and buying a house — need shareholder approval. More on that in a moment. Stay with the first one, because that is the twist in this episode. What is an exempt private company? The definition sets two conditions that must both hold. One: no company holds a beneficial interest in the shares, directly or indirectly — not a single corporate shareholder on the register of members. Two: not more than twenty shareholders. So — the moment you put a holding company onto the register of members, you are no longer an exempt private company. That director's debit balance that has been sitting in the books is unlawful from that day on. Plenty of bosses do a group restructuring, or transfer their shares to their own holding company for succession — and that is the day they crossed the line. Most of the time, nobody tells them.

The clock on approval and repayment

For those two exceptions that need shareholder approval, the provision is very tight on timing. The best practice: approval before the event. Use a resolution that states what the money is for and how much it is. Both have to be written in. And if there was no prior approval? There is still a remedy — for a private company: ratify within six months of the loan being made. And if it is not ratified either? For a private company: the money must be repaid in full within twelve months of the loan being made. (The timetable for a public company is different, and hangs off the annual general meeting; that is not this audience's home ground, so we will leave it on a card.) One last line, boss, and please listen closely: if approval cannot be obtained, the directors who authorised the loan are jointly and severally liable to indemnify the company for its loss. Jointly and severally means the company does not swallow it — the few people who signed pay out of their own pocket. As for the penalty: a person who authorised it, on conviction, faces imprisonment of not more than five years, or a fine of not more than three million ringgit, or both. And one more thing, because people often get this wrong: unlawful does not mean the money is written off. The company can still come after you for it. You pay on both counts.

Even if it is lawful, there is still tax

At this point some bosses breathe out: "I am an exempt private company, so I am fine." Fine under the Companies Act. Not finished under the tax law. These are two completely different Acts. Section 140B of the Income Tax Act 1967: where a company uses its own money — the provision says internal funds — to lend or advance money to a director without interest, or at interest below the market level, the company is treated as having received that interest, and pays tax on interest it never received. The calculation runs month by month: one twelfth, multiplied by the balance outstanding at the end of that month, multiplied by the average lending rate for that month. Work it out separately for each of the twelve months, add them up, and that is the deemed interest income for the year. An example — and the rate is an assumption: a month-end balance of one hundred thousand ringgit, at an assumed rate of four point five per cent for that month, comes to about three hundred and seventy-five ringgit for that month. One month does not look like much. But it is calculated every month, and for as long as that money sits under your name, it does not stop.

The general manager with five per cent

Last, a place a lot of people mix up. The word "director" is defined differently by the Companies Act and by the tax law. The Companies Act does not look at how many shares you hold. Sit on the board and you are a director. The tax law looks at two things, and both must hold. One: you are a director — or a manager, or you otherwise take part in the management of the company — and you draw a salary from the business. Two: you, alone or together with associates, own or control not less than twenty per cent of the ordinary share capital. So you get this situation: a general manager, deeply involved in management, holding five per cent — under the tax law he is not a director, and section 140B cannot reach him. But if he holds twenty per cent, or he and his wife and his parents add up to twenty per cent, then he is. And it works the other way too: a nominee director with no shares at all is not a director for tax, but he is one under the Companies Act, and if the company lends him money, section 224 applies just the same. The two Acts each count on their own terms. Do not reason from one to the other.

To close

One line to close: do not let the auditor at the year end be the first person who ever asks you what the director's current account line actually is. Take that line apart and it usually takes one afternoon. Leave it until something goes wrong and the price is a different matter altogether. Want that line sorted out, and the resolutions that should be there put in place? Grab a coffee first and talk about your business. For the accounting, come to LTT. I am LTT, helping SME bosses get their accounts straight. Follow us, and see you next time.