CARO clause 3(iv): compliance with sections 185 and 186

CARO clause 3(iv) requires the auditor to report whether the company has complied with the provisions of sections 185 and 186 of the Companies Act in respect of loans, investments, guarantees and security given, and if not, to provide details of the non-compliance; this requires separately testing section 185, which restricts loans and guarantees to directors and entities connected to them, and section 186, which caps and conditions investments, loans, guarantees and security to any other body corporate, since the two sections have different prohibitions, limits and approval requirements, and the exact thresholds should be confirmed against the current Act.

Section 185: loans and guarantees to directors and connected entities

Section 185 generally prohibits a company from advancing a loan, giving a guarantee or providing security in connection with a loan to a director, or to any other person in whom the director is interested, subject to narrow carve-outs such as loans to a managing or whole-time director under a scheme applicable to all employees, or in the ordinary course of business at an arm's-length rate for a company that lends in the ordinary course. Testing starts with identifying every director and every entity in which a director has an interest, then scanning the loans and advances ledger and the guarantee register for any transaction touching that list.

Section 186: investments, loans, guarantees and security to other bodies corporate

Section 186 permits a company to make investments, give loans, or provide guarantees or security to any other body corporate, but caps the aggregate at a percentage of free reserves, securities premium and paid-up share capital (or a higher limit approved by special resolution), requires unanimous board approval for certain transactions and prior approval of a public financial institution if any term loan is subsisting, and requires disclosure of the full particulars including rate of interest in the financial statements.

Testing approach

1. 01Build the related-party and director-interest universe firstList all directors, their relatives, and every entity where a director or relative is a director, member or has a substantial interest, before testing any transaction, since section 185 scope turns entirely on this list.
2. 02Scan the loans, guarantees and investments registers against that universeFlag every loan, guarantee, security or investment touching a listed entity and assess against the section 185 prohibition and its carve-outs.
3. 03Recompute the section 186 aggregate limitCalculate free reserves plus securities premium plus paid-up capital, apply the prescribed percentage cap, and compare to the actual aggregate of loans, investments, guarantees and security outstanding at any point in the year, not just at year end.
4. 04Check board and shareholder approvalsConfirm unanimous board resolution where required, and a prior special resolution where the aggregate exceeds the statutory limit, with the resolution matched to the specific transaction and amount, not a blanket approval used to cover unrelated transactions.
5. 05Check the interest rate disclosureSection 186 requires the rate of interest on loans given to be not lower than the prevailing yield of government securities of a comparable maturity; confirm the rate charged and the disclosure in the notes to accounts.