When we talk about related party or RPT (Related Party Transactions) or any law relating to it, there are multiple authoritative guidance which talk about related party, Related party transaction and their disclosures.
We all know SEBI is harsh towards related party compliances because related party compliances are the compliances where transactions are being controlled by few parties who are in the dominating position or who are in the influencing position, therefore SEBI is inclined towards making these compliances more stringent and more robust, so that no noncompliance will not be there but at the same time these compliances are also making this process very difficult to identify related party and RTP.
RELATED PARTY UNDER SECTION 2(76) OF THE COMPANIES ACT, 2013
Related party is defined as per section 2(76) of Company Act 2013 and also as per Section 2 (1) (zb) of LODR. Let’s start with discussing definition of RP u/s 2(76). With the help of few examples let us identify the related parties
Point 1
A director or his relative ( member of the same HUF, husband, wife, father, stepfather, mother, stepmother, son, stepson, son’s wife, daughter, daughter’s husband, brother, stepbrother, sister, step-sister)
Example :-Mr. A, Mr. B and Mr. C are directors and their relatives are considered as related parties.
Point 2
Key managerial personnel (KMP) or their relative
KMP is a person who has the authority & responsibility for planning, directing & controlling the activity of entity either directly or indirectly including any director, executive director Additional director. Only difference in definition of KMP b/w Company Law and AS is that under AS examples are given for KMP i.e., MD, manager or WTD are KMP but when we talk about company law, there they have given the extended definition of KMP u/s 2(76). So, MD, WTD, Managers, CFO, CS or any such person who is one line below the BOD or who is reporting directly to BOD that person comes under definition of KMP.
Example :-Say, Mr. D is a Company secretary (KMP) so his relatives will be considered related parties
Point 3.
A firm where the director, manager, or relative is a partner.
Example :-Mr. A is a director in ABC ltd simultaneously he is also partner at PAR & Associates i.e. partnership firm. This firm will also be treated as a related party to ABC ltd.
Point 4
If any director, member of Reporting Co is also director or manager in Pvt Co than this Private Co automatically becomes RP of reporting co i.e., they have comman directors or members.
Example :-Mr. B is Director in Reporting Co and is also a director in B Pvt. Ltd – In this case B Pvt. ltd becomes a related party. Even when Mr. B’s relative is a member or director in B Pvt. ltd, this company will be treated as a related party.
Point 5
A public company in which a director or manager is a director and hold along with his relatives of more than 2% of its paid-up capital.
Example :-If in K Ltd acts Mr. A, director along with his father, mother, wife and children hold 10% of paid-up share capital than Mr. A will be a related party.
Point 6
Anybody corporate whose board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instruction of a director or manager.
1. Body corporate includes public company, private company, small or big any company also include one person company, LLP and Foreign company. So, if anybody corporate is accustomed to work on advice of any director or manger than such director or manager along with their company will be RP.
2. Word “Accustomed to act” is important and to established “Accustomed to act” that there should be series of events and a single isolated event or even two would not be sufficient to be covered under this section. So, if ABC ltd’ MD are accustomed to act on the instruction of XYZ company’s directors than XYZ company is RP and such director on whose instruction ABC LTD is working is also RP of ABC ltd.
Point 7
Any person on whose advice or instructions, a director or manager are accustomed to act then such person is considered as related party
For example, if directors are following the instructions of lawyer than lawyer cannot be treated as related party.
Point 8
Any Body Corporate which is
- Holding, subsidiary or an associate company of such company; or
- A subsidiary of a holding company to which it is also a subsidiary (fellow subsidiary)
Point 9
- An investing company or the venturer of the company
- The investing company or venturer of a company means a body corporate whose investment in the company would result the company becoming an associate company of the body corporate (two-way relationship)
RELATED PARTY AS PER REG 2(1)(ZB) UNDER SEBI (LODR)
- Such entity is a related party u/s 2(76) of the Company Act
- Such entity is related party under the applicable AS 18 or IND AS 24.
- Any person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more of shareholding in the listed entity.
If any person being promoter or any entity belonging to promoter group of listed company and such entity or person is holding 20% or more of shares of listed company than such promoter or promoter group will be treated as RP. So, all the procedure, disclosure or approval process have to be followed as are applicable on such RP. This % will change to 10% from 1st April 2023
TRANSACTION WITH RELATED PARTY AND RELATED PARTY TRANSACTION
So, there is very thin line of difference between RPT and transaction with related party.
Every transaction with related party may not be related party transaction as when we are doing transaction with related party it may be at arm length price or in ordinary course of business so in that case such transactions will be with RP but they will not be RPT so we can say every transaction with RP cannot be RPT but every RPT has to be a transaction with related party, so vice versa is not true. If Mr. A is director of ltd company; in that case he is related party to company as per the definition section 2(76) but if he is acting in ordinary course as director only and his remuneration with in threshed limits than here, we have transaction with related party but not RPT.
Generally, we have presumption that whenever RPT exist, transaction occur between parties are not at ARM’s LENGTH basis, that is there is scope of undue advantage and same is always assumed unless it is establish otherwise.
RELATED PARTY TRANSACTIONS
Point 1
Sale, Purchase as supply of goods/materials :- sale/purchase OR supply of goods as materials is done or directly through agent exceed 10% of turnover of company or 100 crore which even is less.
Point 2
Selling or otherwise disposing of buying property of any kind :- Here again if we sell or dispose or buy any property directly or through appointing any agent and the value of such transition exceed 10% of net worth of company as rupees 100 crore whichever is less.
Point 3
Leasing of property of any kind :- Lease rent 10% of the net worth of company or 10 % of turnover of company or 100 crore which even is less.
Point 4
Availing or rendering any service :- Where related person is rendering service himself or through agent and consideration being 10% of turnover or 50 crore which ever less.
Here when we talk about Turnover limit or net worth, it means 10% of turnover of company or rupees 50 crore which ever less.
Here I also want to discuss where we talk about turnover and net worth, then they can see from audited financial of proceeding financial year
Point 5
Appointing of any agent or purchase or sale of goods, materials services or property This I have already discussed in above point as which each point, I have added agent also.
Point 6
Such related party’s appointment to any office or place of people in the company subsidiary company or associate company.
Here when we talk about hiring, then the remuneration shall exceed 2.5 lacs to act cover under this section.
This remuneration includes any salary fees, commission, rent fee, accommodation etc. here I want to state that director is excluded from this position.
Point 7
Under writing the subscription of any securities or derivatives of company underwriting commission paid for subscription of any securities or derivatives of company is also treated as related party transaction
EXCEPTION TO ABOVE RULES
Under section 188, provisions of RPT will not apply :
- If company is government company and contract made with any other government company or with central government or state government or combination of both.
- If contract is made with government company other than listed company and contract is approved by ministry or department of Central government/ State Government.
So, to clarify it further any agreement entered into between government companies or departments, it will not be considered as RPT.
- Where such transaction is entered into by company in its ordinary course of business or transaction which are on arm’s length basis. This point is very crucial and I will be discussing in detail later on.
- Where contract is entered into between holding company and its 100% subsidiary company where their accounts are consolidated at year end and placed before shareholder in general meeting for approval.
- Any transaction that arises out of company arrangement and amalgamation
All these transactions are covered under separate provision of Company Act hence do not attract the requirement of Section 188.
ARM’s LENGTH TRANSACTION
All transaction with associated enterprise should be at arm length i.e., transaction between two related parties undertaken as if they were unrelated so that there is no conflict of interest.
Section 188 is not applicable on transactions if they are made in normal course of business and are at Arm Length Price, therefore no resolution is required when transaction between related party is at arm length, similarly these transactions need not to be entered u/s 189.
Burden to establish that the transaction was on arm’s length would be on the company. The company should create and maintain appropriate and adequate documentation with regard to price and terms of supply.
Since the methodologies and approaches for determining the ‘arm’s length transactions’ have not been prescribed therefore, in such absence, the methodologies / approaches existing under ‘Indian Transfer Pricing Guidelines’ contained in the Income Tax Act 1961 may be adopted.
ORDINARY COURSE OF BUSINESS
The phrase “ordinary course of business” is not explicitly defined under the Companies Act 2013 or rules made there. It is very subjective, judgmental and can vary on case-to-case basis. It appears that the ordinary course of business will incorporate the everyday transactions, customs, and practices of a business and a company.
The ICAI has included the few examples that are considered outside the entity’s standard or ordinary course of business:
1. Complex equity transactions i.e. corporate restructurings or acquisitions.
2. Transactions with foreign entities in areas with weak corporate laws.
3. If no consideration is exchanged, the leasing of premises or rendering of management services by an entity to another party.
4. Sales transactions at abnormally large discounts or huge sales returns.
5. Transactions with circular arrangements. For example, sales with a promise to re-purchase to reduce your profits or losses, anything like that.
Contract transactions whose terms can be changed before expiry.
PROCEDURE FOR APPROVAL RELATED PARTY TRANSACTION
APPROVAL MECHANISM
- Section 188-approval of the BOD applicable to both public and privates’ companies
- Section 188 – approval of shareholders once the threshold limits are crossed
- Section 177- approval of audit committee applicable to only where the companies have listed their specified securities
- Regulation 23 of LODR applicable to where the companies have listed their specified securities
APPROVAL OF BOARD OF DIRECTOR
Prior Consent of the Board of Directors is to be obtained by a resolution at a meeting of the Board unless the related party transaction falls under the exempted category.
1. Every contract or agreement entered into u/s 188(I) shall be referred to boards and should be reported to the board members along with justification for entering into such contract or arrangement should be shared.
2. The Board resolution cannot be passed by way of a circular resolution ie resolution can only be passed after being physically present in the meeting.
3. Any Director who is interested in the transaction shall not be present at the Board Meeting during discussion. So, director who is related party has to physically vacate the board room while board is discussing RPT.
4. The agenda for the board meeting shall disclose details pertaining to the related party and the proposed transaction as prescribed in the Rules
5. Where any contract is entered into by director or by any other employee without obtaining the consent of board or approved by resolution in the general meeting than it should be ratified by board or by shareholder with in three months from date of contract otherwise contract will be voidable at the option of board.
AUDIT COMMITTEE
All transactions with related parties require approval of Audit Committee u/s 177 and this approval is not restricted to only RPT u/s 188. Any transaction that is in ordinary course of business and on Arm length price, still require approval of audit committee. Only transaction up to one crore can be ratified by Audit Committee.
Audit committee consists of minimum three directors. These Independent directors should form majority in audit committee.
If any transaction is not authorized by audit committee within three months than such transaction will be Void & director concern will be liable for loss.
OTHER POINT TO BE CONSIDERED
- The approval required is prior approval
- Audit committee may make omnibus approval, for RPT subject to certain conditions
- Both Companies Act 2013, and LODR prescribed more or less similar conditions for granting omnibus approval.
Omnibus Approval
Omnibus Approval means a consolidated/standing approval given by the Committee in respect of transaction(s) which are repetitive in nature.
1. Audit committee shall after obtain approval of the board can specify the criteria for making the omnibus approval which shall include
- Maximum value of the transactions in aggregate in a year.
- Maximum value per transaction.
- Extent and manner of disclosures to be made
- Review of such transactions at periodic intervals
- Transaction which cannot be covered for the omnibus approval
2. While specifying the criteria
- Repetitiveness of the transactions (in past or future)
- Justification for the need of omnibus approval, shall be considered
3. Omnibus approvals are valid for a period not exceeding’s one financial year.
4. Omnibus approval shall not be given for transactions in respect of selling or disposing of undertakings
ADDITIONAL COMPLIANCES FOR LISTED COMPANY
For listed company the compliances of RPT are very Strick and they have to take extra care while dealing in such transactions. Every listed company has to formulate policy of Materiality of RTP and should clear the threshold limits which should be approved by BOD. All such policies should be reviewed at least once in a year and should also be disclosed on companies’ website.
When we talk about Material transactions, it means any transaction that exceed 10% of T/O as per last year audited financials and
If company is letting out its Brand Usage or is taking Royalty from RP than the threshold limit is 5%of T/O or more.
All material transactions have to be submitted within 30 days from date of consolidating its financial results for half year to Stock exchange & same has to be published on companies’ website in specified format as prescribed by AS.
CONTRACT & AGREEMENT U/S 189 OF COMPANIES ACT, 2013
Every company is required to keep register of contract or agreements in which director are interested form MBP- 4 for
- Recording of disclosure of interest by director
- Recording related party transaction
This register is placed before board meeting & is signed by all direction present in meeting.
- Every director within 30 days of his appointment has to disclose to company his interest in concern and other entities and same is included in the register.
- Register is to be kept at registered office of company & should be open for inspection during office hours. It should be presented in every AGM.
Exception
NO, register is required to be maintain if
- Value of goods sold/purchase during the year does not exceed 5 lacs
- By banking company for collection of bills in ordinary course of business
- In case of Sec 8 companies if value of transaction does not exceed 1 lac.
ACCOUNTING STANDARDS 18 – IND ACCOUNTING STANDARDS 24
IND AS 24 is for listed companies and companies having net worth of more than 250 crore. These companies can be subsidiary, holding, JV or any associate enterprise.
Whereas AS-18, has old guidance and is applicable to non-corporate entity or non-listed entity having Net worth less than 250 crores.
As-18, talk about which type of transaction can be RPT so to begin with:
1. Word Control can exercise either by ownership that holding more than half of voting power or through control over the composition of BOD whether directly or indirectly either as holding-subsidiary relationship or through fellow subsidiary.
2. HERE participation in financial and /or operating policy decision is important BUT NOT CONTROL THOSE POLICIES as control in defined in 1st point.
3. we have discussed RP in detail
Why do we need Related party disclosures?
- Relationship influences the transaction between the reporting entity and related party
- Related party transactions impact the transactions with the unrelated party
- Better corporate governance
- Helps in taking informed decision to the stakeholders
- True and fairness of financial position and performance of the entity
Conclusion
It’s not surprising that every company in its day-to-day business enters into various transactions with individuals/ entities with whom they are related or have shared interests. Although such transactions are themselves legal, they may create disputes of interest or push other illegal situations and impact its financial position. Hence, to preserve the interest of stakeholders and keep transparency in business, such transactions with Related Parties are being regularized by section 188 of Companies Act 2013. The meaning linked with this expression-related-party transaction keeps on clouding our minds
About the Author
Author is Ruchika Bhagat, FCA helping foreign companies in setting up and closure of business in India and complying with various tax laws applicable to foreign companies while establishing a business in India. Neeraj Bhagat & Co. Chartered Accountants, is a well-established Chartered Accountancy firm founded in the year 1997 with its head office at New Delhi.
Author Bio
are limits for RPTs including taxes viz., GST etc or excluding