Director Remuneration- Not a Related Party Transaction

This brief article is aimed at addressing an oft cited query in the professional circles regarding the interpretation of the Companies Act, 2013 (‘the Act’) about whether there is a need and requirement of treating directors’ remuneration as a Related Party Transaction (‘RPT’). The Act, in Section 188, Chapter XII Meetings of Board and its Powers, refers to the concept of ‘RPT’. In the author’s view, there is no requirement of treating Director’s remuneration as a RPT as long as the sum of money paid to the director is the ‘remuneration to which he is entitled as director’.

The definition of ‘Related Party’ as given in Section 2(76) of the Act is as follows-

“(76) “related party”, with reference to a company, means—

(i) a director or his relative;

(ii) …”

The definition of related party clearly indicates that every director is considered to be a related party to the Company. In such a scenario, can it be said that remuneration paid to the directors would constitute a related party transaction? If it were to be so, then all the companies would necessarily have a certain number of related party transactions as the Act states that there shall be a minimum of two directors in a private limited company and three in a public limited company. And in most of the cases, at least one director would charge something from the company for the services rendered by him/her.

If that be so, then it would also increase the compliance burden on Companies to the extent of complying with the framework for Related Party Transactions envisaged under Section 188 of the Act read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014.

However, in the opinion of the author, though a director is unquestionably a Related Party, his/her remuneration paid by the company would not be a Related Party transaction in the sense in which the concept is conceived by the Act.

A reference to Section 188 of the Act is useful to arrive at this conclusion. The relevant portion of sub-section (1) of Section 188 is reproduced hereunder-

Related Party Transaction

188.(1) Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to—

(a) …;

(f) ..such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and

(g) …:

6,10[Provided that no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a 1[resolution]:

5&7[Provided further that no member of the company shall vote on such 1[resolution], to approve any contract or arrangement which may be entered into by the company, if such member is a related party:]]]

8[Provided also that nothing contained in the second proviso shall apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties:]

Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.

Explanation.— In this sub-section,—

(a) the expression “office or place of profit” means any office or place—

(i) where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

The sub-clause (f) of Sub-Section (1) of Section 188 read with explanation of the expression “office or place of profit” clearly brings out that only those sums of money paid to director which is over and above the remuneration to which he is entitled as director, would be considered as a RPT, requiring compliance with Section 188 and the corresponding Rules. This would also mean that mere remuneration paid to the director is not a RPT per se. Hence, there is no requirement of treating director remuneration as a RPT merely because of the fact that a director is a related party to the company.

It would be interesting to objectively understand the meaning of the expression used in the explanation to sub section (1) of Section 188- “remuneration to which he is entitled as director”.

This expression is the dividing line and holds the key to distinguishing whether any sum paid to a director would be liable to be treated as a RPT or not. In this context, it is beneficial to refer the provisions of Section 196 which govern “Overall Maximum Managerial Remuneration and Managerial Remuneration in Case of Absence or Inadequacy of Profits” read with the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014.