Related Party Transactions under Companies Act, 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
RELATED PARTY TRANSACTIONS
Related Party Transactions shall be entered into by the Companies after considering the following provisions.
1. Companies Act, 2013 read with the Rules thereunder
2. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Applicable for listed Companies).
4. Indian Accounting Standard (Ind AS) 24 – Related party disclosures notified under the Companies (Indian Accounting Standards) Rules, 2015.
5. Accounting Standard (AS) 18- Related party Disclosures notified under the Companies (Accounting Standards) Rules, 2006.
In this Article, Attempt has been made to consolidate the provisions of Companies Act, 2013 and Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) governing the Related Party Transactions along with the analysis of various terminologies used in the said provisions.
1.1 For both Unlisted and Listed Companies:
1.1.1: Related party transactions means contracts or arrangements between a company and its related parties with respect to transactions covered in Section 188 of the Companies Act, 2013 (hereinafter referred to as “the Act”). The expression ‘contract or arrangement’ has different connotations under the Act. While ‘contract’ envisages a written / formal binding document, ‘arrangement’ may be with or without a written document.
1.1.2: Section 188 of the Act lists out certain transactions which will be considered as RPT under the Act. The list of RPTs are as follows:
a) sale, purchase or supply of any goods or materials;
b) selling or otherwise disposing of, or buying, property of any kind;
c) leasing of property of any kind;
d) availing or rendering of any services;
e) appointment of any agent for purchase or sale of goods, materials, services or property;
f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
g) underwriting the subscription of any securities or derivatives thereof, of the company:
1.1.3: The requirements prescribed under Section 188 are only applicable to the aforesaid transactions.
1.1.4: As per Second proviso of Section 188(1), related party shall not cast his vote on such Resolution to approve any contract or arrangement which may be entered into by the company.
1.1.5: MCA vide its General Circular dated 17th July, 2014 has further clarified that the ‘related party’ referred to in the second proviso, as stated above, has to be construed with reference only to the contract or arrangement for which the said resolution is being passed. Thus, the term ‘related party’ in the above context refers only to such related party as may be a related party in the context of the contract or arrangement for which the said resolution is being passed.
1.1.6: Further, a transaction of giving loan, making investment, providing guarantee or security is a transaction of a financial nature and is not covered under Section 188 of the Act. However, the requirement of Section 177 of the Act, which mandates the approval of the Audit Committee for all transactions with related parties (subject to the exception of transactions with wholly owned subsidiaries), would continue to apply.
1.2 For Listed Companies:
1.2.1: As per Regulation 2(1)(zc) of SEBI (Listing Obligation and Disclosure Requirement) Regulations, 2015 (“Listing Regulations”),: ‘Related Party Transaction’ means a transfer of resources, services or obligations between a listed entity and a related party, regardless of whether a price is charged and a ‘transaction’ with a related party shall be construed to include a single transaction or a group of transactions in a contract.
1.2.2: As per Regulation 23(1) of Listing Regulations: A transaction with a related party shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during the financial year, exceed 10% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
1.2.3: As per Regulation 23(1A) of Listing Regulations: A transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed five percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
1.2.4: As per Accounting Standard (AS)–18:, ‘Related Party Transaction’ is a transfer of resources or obligations between related parties, regardless of whether or not a price is charged.
1.2.5: As per Ind AS-24: ‘Related Party” Transaction’ as a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.
Now, let us discuss the meaning of “Related party”
2.1: Under Companies Act, 2013 (Applicable to both Listed and Unlisted Companies)
2.1.1: According to Section 2(76) of the Act “related party“, with reference to a company, means—
i. a director or his relative;
ii. a key managerial personnel or his relative;
iii. a firm, in which a director, manager or his relative is a partner;
iv. a private company in which a director or manager or his relative is a member or director;
v. a public company in which a director or manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital;
vi. any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
vii. any person on whose advice, directions or instructions a director or manager is accustomed to act:
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
viii. any body corporate which is—
A. a holding, subsidiary or an associate company of such company;
B. a subsidiary of a holding company to which it is also a subsidiary; or
C. an investing company or the venturer of the company;”;
Explanation.—For the purpose of this clause, “the investing company or the venturer of a company” means a body corporate whose investment in the company would result in the company becoming an associate company of the body corporate.
ix. such other person as may be prescribed;
2.1.2: Rule 3 of Companies (Specification of Definition Details) Rules, 2014, prescribes that a director other than an independent director or key managerial personnel of the holding company or his relative with reference to a company shall also be deemed to be a related party.
2.1.3: As per Section 2(77) of the Act, relative with reference to any person, means anyone who is related to another, if—
i. they are members of a Hindu Undivided Family;
ii. they are husband and wife; or
iii. one person is related to the other in such manner as may be prescribed.
2.1.4: Meaning of Relative: Rule 4 of Companies (Specification of Definition Details) Rules, 2014 prescribes persons who shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely:-
a. Father (includes step-father).
b. Mother (includes the step-mother).
c. Son (includes the step-son).
d. Son’s wife.
f. Daughter’s husband.
g. Brother (includes the step-brother);
h. Sister (includes the step-sister).
2.2 Under Listing Regulations (Applicable Only to Listed Companies)
2.2.1: Regulation 2(1)(zb) of the Listing Regulations defines the term ‘related party’ as follows:
2.2.2: A related party means a related party as defined under Section 2(76) of the Act or under the applicable accounting standards.
2.2.3: Provided that 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 shall also be deemed to be a related party.” (The amended Regulation, to be effective from 1st April, 2019).
2.2.4: It may be noted from the above that in addition to the related parties within the meaning of the Act (as discussed above), the Listing Regulations also include related parties within the meaning of the Accounting Standards.
2.3 Under Accounting Standard-18
Parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions.
Further, AS – 18 applies to the following related party relationships:
a. Enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries);
b. Associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is an associate or a joint venture;
c. Individuals owning, directly or indirectly, an interest in the voting power of the reporting enterprise that gives them control or significant influence over the enterprise, and relatives of any individual.
d. Key management personnel and relatives of such personnel; and
e. Enterprises over which any person described in (c) or (d) is able to exercise significant influence. This includes enterprises owned by directors or majority shareholders of the reporting enterprise and enterprises that have a member of key management in common with the reporting enterprise.
2.4 Under Indian Accounting Standards (Ind AS)
A related party is a person or entity that is related to the entity that is preparing its financial statements (in this standard referred to as the reporting entity)
(a) A person or a close member of that person’s family is related to a reporting entity if that person:
i. has control or joint control over the reporting entity;
ii. has significant influence over the reporting entity;
iii. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
(b) An entity is related to a reporting entity if any of the following conditions apply:
i. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
ii. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
iii. Both entities are joint ventures of the same third party.
iv. One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
v. The entity is a post employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
vi. The entity is controlled or jointly controlled by a person identified in (a).
vii. A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).
viii. The entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.
3.1: The definition of term Agreement under the Competition Act, 2002 includes any arrangement. Such arrangement may be formal or informal, oral or written and may also be a concerted practice. The term arrangement used in the Act would also have the same interpretation.
3.2: The Hon’ble Bombay High Court, in the case of Bank Of India v. Ahmadabad Manufacturing & Calico Printing Co. Ltd.(1972) 42 Comp. Cases 211 (Bom), while interpreting the word ‘arrangement’ as appeared in Section 390 of the Companies Act, 1956, has observed as under:
3.3: “The word ‘arrange’ has, as one of its meaning, in the Shorter Oxford Dictionary, 3rd edition, ‘to come to an agreement or understanding’, and the word ‘arrangement’ has, as its primary meaning, ‘the action of arranging’. As a matter of plain language it would, therefore, follow that the term ‘arrangement’ means any agreement or understanding between the parties concerned.”
3.4: The Hon’ble Division Bench of Karnataka High Court, in the case of KV Kuppa Raju v. Government of India (1997) 224 ITR 169 (Mad), has noted that the report of an Expert Group to rationalize and simplify Income Tax law had given the following definition of “arrangement”.
3.5: ‘Arrangement’ means any scheme, trust, grant, understanding, covenant, agreement, disposition, transaction and includes all steps by which it is carried into effect.
4.1: The Act does not clearly state the definition of Ordinary course of business, however, in common parlance, ‘ordinary course of business’ would include transactions which are entered into in the normal course of the business pursuant to or for promoting or in furtherance of the company’s business objectives, as per the charter documents of the company. For example, in case of a manufacturing company, purchase and sale of goods, taking premises on lease/rent, construction of factory, employing workers, etc. will be considered as ordinary course of business. To carry on a business, several activities are carried on by the company; all such activities will be considered to be in the ordinary course of business.
4.2: To decide whether an activity which is carried on by the business is in the ‘ordinary course of business’, the following factors may be considered:
a. Whether the activity is covered in the objects clause of the Memorandum of Association
b. Whether the activity is in furtherance of the business
c. Whether the activity is normal or otherwise routine for the particular business (i.e. activities like advertising, staff training, etc.)
d. Whether the activity is repetitive/frequent
e. Whether the income, if any, earned from such activity/transaction is treated as business income in the company’s books of account
f. Whether the transactions are common in the particular industry
g. Whether there is any historical practice to conduct such activities
h. The financial scale of the activity with regard to the operations of the busuiness
i. Revenue generated by the activity
j. Resources committed to the activity
4.3: The above list is not exhaustive. Individually, none of the above parameters can amounts to the transactions being in the ordinary course of business.
4.4: In other words, any activity which is routine and in accordance with the usual customs and practices of a particular business can be described to be ‘in the ordinary course of business’. For a company, the interpretation needs to be contextual, taking into account the nature of the activity and its relevance in the overall context of the company’s businesses
5.1 Under Companies Act, 2013
As per Explanation to sub-section (1) of Section 188 of the Act, the term ‘arm’s length transaction’ as a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.
Suppose company ABC Ltd. sells a product in the market for Rs. 100 per unit and it also sells the same to its Subsidiary company XYZ Ltd. for Rs. 100 per unit and on the same terms of contract as with other parties. Here, the price charged from the Subsidiary company and others is the same and the transaction between ABC Ltd. and XYZ Ltd. is governed by market forces and, therefore, is on arm’s length basis.
5.2 Under Income Tax Act, 1961
5.2.1: As per Section 92F of the Income-tax Act, 1961, “arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.
5.2.2: In terms of Section 92C of the Income-tax Act, 1961, the arm’s length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of the transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board of Directors of the company may prescribe, namely:-
a. comparable uncontrolled price method;
b. resale price method;
c. cost plus method;
d. profit split method;
e. transactional net margin method;
f. Such other method as may be prescribed
5.2.3: The other method for determination of the arm’s length price shall be any method which considers the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.
5.2.4: The most appropriate method shall be applied, for determination of arm’s length price. Where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices.
5.2.5: Hence, while identifying the Arm’s Length Price, both of the above provisions should be fulfilled by the Company.
5.2.6: Further it is also to be noted that Price in isolation cannot be the only criteria. Terms of sale such as credit terms should also be considered.
5.3 Parameters which may be used that whether the proposed transaction will be on Arm’s length basis or not.
5.3.1 The company’s policy on transactions with related parties.
5.3.2 Transfer Pricing guidelines given under the Income-tax Act, 1961.
5.3.3 The Audit Committee may decide whether a particular transaction is in the ordinary
Section 188 of the Act and Regulation 23 of the Listing Regulations deal with transactions with related parties.
Approval by the Board is necessary if the transaction with a related party is covered under Section 188(1) of the Act but does not exceed the thresholds under Rule 15 of the Companies (Meetings of the Board and its Powers) Rules, 2014.
Approval of the shareholders is required in all cases where the transaction exceeds the thresholds referred to above.
The Act provides for approval of all transactions with related parties by an Audit Committee except with respect to transactions with a wholly owned subsidiary. If the transaction is in the ordinary course of business and on arm’s length basis then approval of the Audit committee will be necessary (under section 177(4)(iv) of the Act) however approval of the Board of Directors will not be required in this regard.
6.1.1: In terms of Section 177 of the Act, all companies which are required to constitute an Audit Committee, or which have constituted an Audit Committee voluntarily, would require approval or subsequent ratification of the audit Committee for all transactions with related parties. Subsequent modification to related party transactions would also require approval of the Audit Committee.
6.1.2: Considering that Section 177 of the Act does not relate or refer to Section 188 of the Act, approval of the Audit Committee is required for all related party transactions irrespective of whether they are in the ordinary course of business or not or whether they are on an arm’s length basis or not.
6.1.3: Further, the Audit Committee may make omnibus approval (valid for a period not exceeding one financial year) for related party transactions proposed to be entered into by the company and shall consider the following factors while specifying the criteria for making omnibus approval, namely: –
(a) repetitiveness of the transactions (in past or in future);
(b) justification for the need of omnibus approval.
The omnibus approval shall contain or indicate the following: –
(a) name of the related parties;
(b) nature and duration of the transaction;
(c) maximum amount of transaction that can be entered into;
(d) the indicative base price or current contracted price and the formula for variation in the price, if any; and
(e) any other information relevant or important for the Audit Committee to take a decision on the proposed transaction:
6.1.4: Provided that where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.
6.1.5: Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.
6.1.6: Where a company enters into any related party transaction without prior approval, the company may ratify such transaction within three months to avoid any penal consequences.
6.1.7: In case any transaction involving any amount not exceeding one crore rupees is entered by a director or officer of the Company without obtaining the approval of the Audit Committee and it is not ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be voidable at the option of the Audit Committee and if the transaction is with a director’s related party or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by the company from such transaction.
As per Section 188(1) of the Act, A company shall enter into following contract or arrangement with a related party only after approval of Board of Directors:
a. sale, purchase or supply of any goods or materials;
b. selling or otherwise disposing of, or buying, property of any kind;
c. leasing of property of any kind;
d. availing or rendering of any services;
e. appointment of any agent for purchase or sale of goods, materials, services or property;
f. such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
g. underwriting the subscription of any securities or derivatives thereof, of the company.
Prior approval of the shareholders by way of an Ordinary resolution shall be required for the following related party transactions which are either not in the ordinary course of business or not on an arm’s length basis, where the transaction(s) to be entered into, either individually or taken together with previous transactions during the financial year, exceeds the following threshold limits:
a. sale, purchase or supply of any goods or material, directly or through appointment of agent, amounting to ten percent or more of the turnover of the company.
b. selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, amounting to ten percent or more of net worth of the company.
c. leasing of property any kind amounting to ten per cent or more of the turnover of the company.
d. availing or rendering of any services, directly or through appointment of agent, amounting to ten percent or more of the turnover of the company.
e. appointment to any office or place of profit in the company, its subsidiary company or associate company at a monthly remuneration exceeding two and a half lakh rupees.
f. remuneration for underwriting the subscription of any securities or derivatives thereof, of the company exceeding one percent of the net worth of the Company.
Note: The turnover or net worth referred in the above sub-rules shall be computed on the basis of the audited financial statement of the preceding financial year.
6.4.1: All related party transactions by the Listed Companies shall require prior approval of the Audit Committee.
6.4.2: Shareholders approval by way of Ordinary Resolution shall be obtained for all material related party transactions.
Note: it may be noted that shareholders approval is required irrespective of whether the transaction is in the ordinary course of business or whether the same is on arm’s length basis.
6.4.3: The Act provides for individual thresholds for each type of related party transaction for the purpose of taking shareholder’s approval through ordinary resolution. However, the Listing Regulations prescribe a common threshold i.e. 10% of annual consolidated turnover for transaction(s) to be termed as material related party transaction, for which approval of shareholders is required. For this purpose, it is noteworthy that all such transactions are to be taken together, provided the said transactions are undertaken under a common contract. In some cases, this might lead to a situation in which a transaction, which otherwise would be exempt from shareholder’s approval under the Act, might have to be approved by the shareholders under the Listing Regulations, or vice versa.
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