Prohibition of Acceptance of Deposits for the purpose of Lending by Unincorporated Business under the RBI Act, 1934

Section 45S of the RBI Act, 1984 prohibits any person being an individual, a partnership firm or an unincorporated association of individuals from accepting deposits if

(a) his or its business, wholly or partly includes –

  1. the financing, whether by way of making loans or advances or otherwise, of any activity other than its own;
  2. the acquisition of shares, stock, bonds, debentures or securities issued by a Government or local authority or other marketable securities of a like nature;
  3. letting or delivering of any goods to a hirer under a hire-purchase agreement as defined in clause (c) of section 2 of the Hire-Purchase Act, 1972;
  4. the carrying on of any class of insurance business;
  5. managing, conducting or supervising, as foreman, agent or in any other capacity, of chits or kuries as defined in any law which is for the time being in force in any State, or any business, which is similar thereto;
  6. collecting, for any purpose or under any scheme or arrangement by whatever name called, monies in lumpsum or otherwise, by way of subscriptions or by sale of units, or other instruments or in any other manner and awarding prizes or gifts, whether in cash or kind, or disbursing monies in any other way, to persons from whom monies are collected or to any other person, but does not include any institution, which carries on as its principal business, (a) agricultural operations; or (aa) industrial activity; or (b) the purchase or sale of any goods (other than securities) or the providing of any services; or (c) the purchase, construction or sale of immovable property, so however, that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons.

(b) principal business is of accepting deposits or of lending in any manner.

However, they are permitted to accept deposit by way of loan from the relatives of the individual or in case of a partnership firm, the relatives of the partners in the partnership firm.

“Relatives” from whom deposits can be accepted.

The term “deposit” includes and shall be deemed always to have included any receipt of money by way of deposit or loan or in any other form, but does not include,–

  1. amounts raised by way of share capital;
  2. amounts contributed as capital by partners of a firm;
  3. amounts received from a scheduled bank or a co-operative bank;
  4. amounts received from State Financial Corporation or other Public Financial Institution;
  5. amounts received in the ordinary course of business, by way of– (a) security deposit, (b) dealership deposit, (c) earnest money, (d) advance against orders for goods, properties or services;
  6. any amount received from an individual or a firm or an association of individuals not being a body corporate, registered under any enactment relating to money lending which is for the time being in force in any State; and
  7. any amount received by way of subscriptions in respect of a chit.

Section 58B(5A) deals with provisions for prosecution & penalty for contravention of Section 45S of the RBI Act, 1934. It provides for punishment by way of imprisonment for a term which may extend to two years or with fine which may extend to two times the amount of deposit received in contravention subject to a minimum of Rs. 2000/- or with both.

Further, in the absence if special and adequate reasons to be mentioned in the judgement, the term of imprisonment shall not be less than 1 year and fine shall not be less than Rs. 1000/-.

Implications under the Income Tax Act, 1961

The Finance Act, 1998 inserted an Explanation 1 to section 37(1) of the Income Tax Act, 1961 which is reproduced as follows:

“For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business of profession and no deduction or allowance shall be made in respect of such expenditure. “

In the matter of CIT vs Shri Arun Thomas in ITA No. 100/2016, the Kerala High Court vide Order dated 03/10/2017 wherein it was HELD that accepting deposits is prohibited by law and paying interest on deposits is that of expenditure on an activity prohibited by law. Therefore, any interest paid on deposits is not to be allowed as deduction u/s. 36(1)(iii) of the Act.

However, the appeal to the aforesaid judgement of the Hon’ble Kerala High Court is pending before the Hon’ble Supreme Court of India in Writ Petition No. 33432-31437/2017 dated 24/11/2017.

Implications in Audit of Financial Statements

The Standard on Auditing (SA) 250 Consideration of Laws and Regulations in an Audit of Financial Statements issued by ICAI deals with the auditor’s responsibility to consider laws and regulations when performing an audit of financial statements.

The auditor is required obtain a general understanding of the legal and regulatory framework applicable to the entity; audit evidence regarding compliance; reporting of Identified or Suspected Non-Compliance to Those charged with Governance, In the Auditors Report on Financial Statements and To Regulatory and Enforcement Authorities.