Related Party Transactions- Section 188 – Companies Act 2013: An Insight

Before understanding Related party Transaction, First of all we have to understand Related Party.

Who is Related Party?

Section 2(76) of Companies Act, Related party with reference to Company means:

• A Director or his Relative
• A KMP or his Relative
• A firm in which Director, Manager or his relative is a Partner
• A private Company in which such Director, Manager or his relative is a Member or Director
• A public Company in which a Director or Manager is a Director and holds along with Relatives more than 2% of its Paid up capital
• Any Body Corporates whose Board of Directors, Managing Director or Manager is accustomed to the act
• Any person on whose advice, directions or instructions , a Director or manager is accustomed to the act

IMPORTANT Note: Nothing in the last 2 clauses shall apply to the advice, directions or instructions given in a professional capacity

• Any Company which is holding Company, Subsidiary or associate Company of such Company
• A Subsidiary of a Holding Company to0 which it is also a Subsidiary

Important note: The last 2 points mentioned above shall not apply with respect to Related Party Transactions to a Private Company vide Notification dated 5 June 2015

• Any other Person as may be prescribed.

WE also need to understand the definition of Relative as per section 2(77)

• Anyone who is related to other if :
  • They are members of Hindu Undivided Family
  • They are husband and wife
  • One person is related to other in such a manner as may be prescribed :

Most Important Points: person as may be prescribed is defined under Rule 4 of Companies specification of definition rule

• Father including step father
• Mother including step mother
• Son including step son
• Son’s wife
• Daughter
• Daughter’s husband
• Brother including step brother
• Sister including step sister

Related Party Transactions useful Points

♠ A Company shall enter into any contract or arrangement with a Related Party only after taking consent of Board of Directors BY PASSING Board Resolution at Board Meeting with Respect to :

1. Sale, purchase or supply of any goods or materials
2. Appointment of any agent for purchase or sale of goods, materials , services or property
   

Interpretation:kindly refer Rule 15 of Meeting of Board and Power Rule

Sale, purchase or supply of goods or materials directly or through appointment of agent exceeding 10% of total turnover of company or 100 crore rupees whichever is lower

Such Contract arrangement shall be entered by the Company by passing resolution in general meeting.

Point to be noted:The word special resolution shall BE AMENDED WITH THE WORD RESOLUTION VIDE Notification dated 29^th May 2015

3. Selling or otherwise disposing of or buying property of any kind

Point to be considered:Property includes securities also.

Interpretation:Kindly refer Rule 15 of Meeting of Board and Power Rules

Kindly Read section 180 with this point to co- relate this point.

Selling or otherwise disposing of or buying property of any kind directly or through appointment of agent exceeding 10% of net worth of Company or rupees 100 crores whichever is lower.

Such Contract or arrangement shall be entered by Company by passing resolution in general meeting

4. Leasing of Property of any kind

Interpretation:Kindly refer Rule 15 of Meeting of Board and Power Rule

Kindly Read Section 180 with this point to Co-relate the point

Leasing of property of any kind exceeding10% of the net worth of the Company or 10% of turnover of Company or 100 crore rupees whichever is lower.

5. Availing or rendering of any services.

Interpretation: Now, here question arises weather loan given by Holding Company to wholly owned Subsidiary Company comes under purview of Related Party transaction?

The Answer is No,

Reason– if  Holding Company primary business is giving loan and accepting deposit from the public, then such transactions are covered under Related Party Transaction because here holding Company’s primary function is giving loans.

For Example: Banks accepts and provides Loan to Customers on daily basis.

Other than this, No Related Party Transaction will be attracted.

Limits: availing or rendering of any services, directly or through appointment of agent exceeding 10% of Turnover or 50 crores Rupees whichever is lower.

POINT TO BE NOTED: LIMITS SPECIFIED IN ABOVE CLAUSES SHALL APPLY TO TRANSACTION OR TRANSACTIONS TO BE ENTERED INDIVISUALLY OR TAKEN TOGETHER WITH THE PREVIOUS TRANSACTION DURING A FINANCIAL YEAR

6. Such Related Party’s appointment to any office or place of profit in the Company, its Subsidiary Company or associate Company
   

⇒ Interpretation– Kindly refer Rule 15 of Meeting of Board and Power Rules

Appointment of any office or a place of profit in a Company, its subsidiary company or associate company at a monthly remuneration exceeding 2.5 Lakhs Rupees.

Important Note: No member of the Company shall vote on such resolution to approve any contract or arrangement which may be entered by the Company if such member is a related party.

Points to be noted:

• The above important Note shall not be applicable to Government Company in respect of Contract or arrangement entered by it with any other Government Company vide notification dated 5^th June 2015
• This important point shall not applicable to private company vide notification dated 5^th June 2015

Important Note: Nothing in section 188(1) shall apply to the transactions entered by the Company in its ordinary course of business and transactions which are at Arm length basis.

What is ordinary Course of Business?

The activities that are normal, necessary and incidental to business are covered under ordinary course of business.

Example: A contractor works with financial institution to secure a loan to continue the project.

What are arm length Transactions?

Arm Length transaction is transaction between two related party without any pressure and they are conducted as they are unrelated so that there is no conflict of interest.

Each of the independent parties are expected to get best possible deal done.

For example: if Company is selling machine to other company at Rupees 25000, but fair market value is 50,000. Then such Transaction is not at arm length price as there is conflict of interest.

New Amendment: for approving related party transaction under section 188(1), the requirement of passing the resolution shall not be applicable for transactions entered between holding Company and wholly Owned Subsidiary Company whose accounts are consolidated with Holding Company and placed before the shareholders at General Meeting for approval.

 Important points for omnibus approval

• Companies need to take prior permission from Audit Committee to approve Related Party Transactions
• Audit Committee shall make omnibus approval to approve Related Party Transactions

Point to be noted- Before approval of Audit Committee to grant omnibus approval, prior approval of Board is required

The Audit Committee shall consider the following factors while granting Omnibus approval:

• Maximum value of transaction in aggregate that can be allowed during the year
• Maximum value per transaction that can be allowed
• Review of each Related party transaction after omnibus approval
• Disclosures made to Audit Committee at time of omnibus approval
• Transactions which cannot be subject to omnibus approval by Audit Committee

Factors specifying the Omnibus approval

• Such approval shall be applicable to those related party transactions which are repetitive in nature
• The omnibus approval shall specify :
• Name of Related Party
• Nature of Transaction
• Period of Transaction
• Maximum amount of transaction that can be entered into
• Any other condition as Audit Committee may deem fit

Important Note: Omnibus approval without fulfilling the above criteria

Audit Committee may grant omnibus approval for a transaction not exceeding 1 crore rupees per transaction

Point to be noted: Omnibus approval shall be valid for a period of 1 year and after expiry of 1 year, fresh approval is required.

Important Note: The word omnibus is used to approve two or more matters independently.

Omnibus approval shall be made for transactions for selling or buying of undertakings of the Company

Any other item as it may deem fit

Important Note: The omnibus approval shall expire at the end of financial year of company. For approving related party transactions, a fresh approval is required after commencement of new financial year but not before that period.

Point to be noted:  The word omnibus approval is given under section 177(4)(iv) proviso which states that for approving related party transaction, omnibus approval of audit Committee is required.

Point to be noted: A related party transaction which is not repetitive in nature may not get omnibus approval even if such transaction takes placed more than one time.

Some important points of related party transactions given under Rule 15 of (Meeting of Board and power Rules)

• Where Director is interested in in any Contract or arrangement with a related party, such Director shall not be present in a meeting during such discussion on subject matter of resolution relating to such contract or arrangement
• ]in case of wholly owned subsidiary Company, resolution passed by holding company shall be sufficient for the purpose of entering the transactions between holding Company and wholly owned subsidiary Company
• Explanatory statement to be annexed to the notice of General Meeting shall contain following particulars namely :
  • Name of Related Party
  • Name of Director or KMP who is related if any
  • Nature of relationship
  • Nature, monetary value and particulars of contract or arrangement
  • Any other information important for the members to take a decision on the proposed resolution.