“Ensuring Fairness: Guide to Section 188 for Related Party Transactions in Pvt Ltd Companies – Navigate related party transactions with transparency.”
Transparency and Accountability: Implementing Section 188 for Related Party Transactions in Private Limited Companies
Related party transactions (RPT) are a common occurrence in business, and it is crucial for private limited companies to navigate them carefully. Under the Companies Act, 2013, related party transactions are regulated to ensure fairness and transparency in corporate dealings. This guide will provide a crisp and clear understanding of related party transactions for private limited companies.
RPT refers to any transaction that takes place between a company and its related parties, such as directors, key managerial personnel, and their relatives. Section 188 of the Companies Act, 2013 provides guidelines for such transactions to ensure that they are fair and transparent.
Under section 188, a private company can enter into an RPT only after obtaining prior approval from the board of directors. In case the transaction exceeds the prescribed limits, approval from shareholders is also required. The company is also required to disclose the details of the transaction in its financial statements.
For example,
let’s say a private company ABC Ltd. intends to rent office space from a company owned by its director, Mr. X. As per Section 188, ABC Ltd. must obtain prior approval from its board of directors for this transaction. The approval must be obtained before the transaction takes place. In case the rent exceeds the prescribed limits, approval from shareholders must also be obtained. The company must also disclose the details of the transaction in its financial statements.
Definition of related party transactions:
- Transactions occur between two parties that have a pre-existing relationship with each other.
- Can include sales, purchases, or other financial dealings, and can occur between individuals, companies, or other entities.
- Regulated under Section 188 of the Companies Act, 2013.
Key managerial personnel (KMPs) and their relatives:
- KMPs include the CEO, MD, Manager, Company Secretary, and any person appointed as a KMP by the Board of Directors.
- Relatives of KMPs include spouse, father or mother (including step-mother and father), son or son’s wife, daughter or daughter’s husband, brother or sister (including step-brother and step-sister).
- If any of the above KMPs, or their relatives, hold substantial ownership or control in another company, then transactions between that company and ABC would be considered related party transactions under the Act.
Director’s salary and perquisites control mechanisms:
- Appointment of Remuneration Committee consisting of independent directors and other members to recommend and approve the remuneration and perquisites of directors.
- Disclosure and Approval of director’s salary and perquisites in the annual report of the company, along with the details of any related party transactions.
- Compliance with Laws to ensure that the director’s salary and perquisites comply with the applicable laws and regulations, including the Companies Act, 2013, and the Income Tax Act, 1961.
- Independent Audit to ensure that the director’s salary and perquisites are fair and reasonable, and that there is no abuse of power or related party transactions.
Substantial ownership or control:
- A person is considered to hold substantial ownership or control if they hold 20% or more of the equity share capital of the company, or have the right to exercise significant influence or control over the company.
- This definition of substantial ownership or control applies to companies and limited liability partnerships (LLPs) registered under the Companies Act, 2013.
- Trust holding or proprietorship business are not registered as companies or LLPs under the Companies Act, 2013. Therefore, the provisions regarding related party transactions do not directly apply to them.
- If the trust or proprietorship business is a related party to a company or LLP as defined under the Act, then any transactions between the two entities must comply with the related party transaction provisions under Section 188 of the Act.
- The company or LLP must disclose details of the related party transactions in its annual financial statement as per the Act’s requirements.
The private limited companies must navigate related party transactions carefully under the Companies Act, 2013. Companies must follow the provisions of Section 188 of the Act and implement control mechanisms to ensure that related party transactions are conducted transparently and fairly. It is also important to identify substantial ownership or control to determine whether the provisions regarding related party transactions apply.
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