Related Party Transactions
Author: Meghana V
Email id: meghana@simplybiz.in
A. Overview
A brief definition of Related Parties, Related Party Transactions, approval requirements for entering into Related Party Transactions, and the impact on entering into Related Party Transactions as per the Companies Act, 2013 are covered in this article.
B. Introduction
Related Party Transactions (RPT) refer to transactions between two entities that have a close relationship, such as a parent company and a subsidiary, two companies under common ownership, or between companies and their executives or directors.
RPTs can create potential conflicts of interest, and there is a risk that they may not be conducted at arm’s length price, one party may be receiving more favorable terms than they would in a transaction with an unrelated party.
An arm’s length price is the price that would have been agreed upon between independent parties under normal market conditions, without the influence of any relationship between the parties.
C. Laws governing Related Party Transactions:
- Section 2(76), 188, 177 and 184 of the Companies Act, 2013
- Regulation 23 read with Schedule V of SEBI (LODR) Regulations, 2015
- Accounting Standards (AS-18) and Indian Accounting Standards (IAS-24)
- D. Who is a Related Party?
Now, let us the understand the meaning of Related Party, as per sub-section (76) of Section 2 of the Companies Act, 2013, related party with reference to a company means:
- A director or his relative
- Key Managerial Personnel or his relative
- Firm in which director or manager or his relative is partner
- Private company in which a director or 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 his relatives, more than two percent (2%) of its paid-up share capital
- Anybody corporate whose Board of Directors or Managing director or Manager is accustomed to act in accordance with the advice, directions or instructions of a director or many person on whose advice, directions or instructions a director or manager is accustomed to act, except if given on professional capacity
- Any body corporate which is –
- a holding, subsidiary, or an associate company of such company
- a subsidiary of a holding company to which it is also a subsidiary or
- an investing company or the venturer of the company.
E. What are Related Party Transactions?
Companies often deal with the parties with whom they are familiar or have common interest, RPTs refers to contract or arrangement made between two parties who are joined with preexisting business relationship or having common interests.
Following are the Related Party Transactions and threshold limits as per Section 188 of the Companies Act, 2013 read with rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014:
Nature of Contract / Arrangement with Related Party | Threshold limit |
Sale, purchase or supply of any goods or materials | 10% or more of the turnover |
Selling or otherwise disposing of, or buying, property of any kind | 10% of net worth of the company |
Leasing of property of any kind | 10% or more of the turnover |
Availing or rendering of any services | 10% or more of the turnover |
Appointment of any agent for purchase or sale of goods, materials, services or property | 10% or more of the turnover |
Such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company | Monthly remuneration exceeding Rs. 2,50,000/- |
Underwriting the subscription of any securities or derivatives thereof, of the company | Remuneration exceeding 1% of the net worth. |
F. Nature of approval required
- Approval from the Board of Directors and Shareholders:
Transactions between related parties that are not in the ordinary course of business or are not transacted at arm’s length will require prior approval from the Board.
In addition to the Board’s approval, a special resolution from shareholders is also required if a transaction between related parties exceeds the threshold limit as outlined under the definition of RPTs above.- What if the approval is not taken by the board or shareholders?
Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the board or approval by shareholders in the general meeting the same can be ratified by the Board or by the shareholders as the case maybe at a meeting within three months from the date on which such contract or arrangement was entered. - What if the contract/arrangement is not ratified within three months?
A contract or arrangement that is not ratified within three months is voidable at the discretion of the Board or shareholders as the case maybe. - Consequences of not complying the above provisions:
- The Company may proceed against a director/employee, who had entered into contract or arrangement in contravention of the provisions, for recovery of any loss sustained by it as a result of such contract or arrangement.
- Director or any other employee of a company who had entered into or authorized the contract or arrangement in violation of the provisions of this section will be liable to a penalty of five lakh rupees and in case of listed companies twenty-five lakh rupees.
- What if the approval is not taken by the board or shareholders?
Note:
- Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.
- The members of the company who are related parties to the contract or arrangement may not vote on any resolution to approve the contract or arrangement.
Exceptions:
- A resolution is not required for transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated with the holding company and are presented to shareholders at the general meeting for approval.
- In case of a private limited company, If the member of the company is related party, he my vote on such resolution and in case of a company other than private limited company if 90% or more members, in number, are relatives of promoters or are related parties a member may vote on such resolution.
d. Approval from the Audit Committee
Section 177 of Companies Act, 2013 mandates to take approval from the Audit Committee for all the RPTs if the Audit Committee requirements are applicable to the Company.
Approval for entering into every contract/arrangement with related parties, require submission of each individual transaction to the Board of Directors and Audit Committee for approval which can be time-consuming for the corporates.
In order to reduce the administrative burdens, omnibus approval is more efficient and streamlined process for approving regular or low risk transactions.
F. Nature of approval required
- 1. Approval from the Board of Directors and Shareholders:
- 1.1. What if the approval is not taken by the board or shareholders?
- 1.2. What if the contract/arrangement is not ratified within three months?
- 1.3. Consequences of not complying the above provisions:
- The Company may proceed against a director/employee, who had entered into contract or arrangement in contravention of the provisions, for recovery of any loss sustained by it as a result of such contract or arrangement.
- Director or any other employee of a company who had entered into or authorized the contract or arrangement in violation of the provisions of this section will be liable to a penalty of five lakh rupees and in case of listed companies twenty-five lakh rupees.
Transactions between related parties that are not in the ordinary course of business or are not transacted at arm's length will require prior approval from the Board.
In addition to the Board's approval, a special resolution from shareholders is also required if a transaction between related parties exceeds the threshold limit as outlined under the definition of RPTs above.
Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the board or approval by shareholders in the general meeting the same can be ratified by the Board or by the shareholders as the case maybe at a meeting within three months from the date on which such contract or arrangement was entered.
A contract or arrangement that is not ratified within three months is voidable at the discretion of the Board or shareholders as the case maybe.
Note:
- Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement.
- The members of the company who are related parties to the contract or arrangement may not vote on any resolution to approve the contract or arrangement.
Exceptions:
- A resolution is not required for transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated with the holding company and are presented to shareholders at the general meeting for approval.
- In case of a private limited company, If the member of the company is related party, he my vote on such resolution and in case of a company other than private limited company if 90% or more members, in number, are relatives of promoters or are related parties a member may vote on such resolution.
- 1.4. Approval from the Audit Committee
Section 177 of Companies Act, 2013 mandates to take approval from the Audit Committee for all the RPTs if the Audit Committee requirements are applicable to the Company.
Approval for entering into every contract/arrangement with related parties, require submission of each individual transaction to the Board of Directors and Audit Committee for approval which can be time-consuming for the corporates.
In order to reduce the administrative burdens, omnibus approval is more efficient and streamlined process for approving regular or low risk transactions.
- 2. What is Omnibus approval:
- 1. Audit Committee shall after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:
(a) maximum value of transactions that can be allowed in a year
(b) maximum value per transaction which can be allowed (c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval
(d) review, at such intervals as the Audit Committee may deem fit; related party transaction entered into by the company under each of approval made
(e) transactions which cannot be subject to the Omnibus by the approval Audit Committee - 2. The Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –
(a) Repetitiveness of the transactions (in past or future)
(b) Justification for the need of omnibus approval - 3. Omnibus approval shall be valid for one financial year and shall require fresh approval after the expiry of such financial year.
- 2.1. What if the approval is not taken by the Audit Committee:
- 2.2. What if the contract/arrangement is not ratified within three months?
- 2.3. Consequences of not complying the above provisions: Noncompliance of the provisions as per Section 177 of the Audit Committee:
- company shall be liable to a penalty of five lakh rupees and
- every officer of the company who is in default shall be liable to a penalty of one lakh rupees.
Omnibus approval means a blanket approval given by the Audit Committee for the transactions entered between the related parties which are repetitive in nature.
For a company to use omnibus approval, it is generally required that the company has an Audit Committee in place, as the Audit Committee is responsible for overseeing the financial reporting process and ensuring that the company's financial statements are accurate and transparent.
Audit Committee may grant omnibus approval for RPTs subject to the following conditions:When the transaction involves a sum not exceeding one crore rupees and is entered into by a director or officer of the company without obtaining the approval of the Audit Committee, the same can be ratified by the Audit Committee within three months from the date of such transaction.
A contract or arrangement that is not ratified within three months is voidable at the discretion of the Board or shareholders as the case maybe.
2. What is Omnibus approval:
- Omnibus approval means a blanket approval given by the Audit Committee for the transactions entered between the related parties which are repetitive in nature.
- For a company to use omnibus approval, it is generally required that the company has an Audit Committee in place, as the Audit Committee is responsible for overseeing the financial reporting process and ensuring that the company’s financial statements are accurate and transparent.
- Audit Committee may grant omnibus approval for RPTs subject to the following conditions:
- Audit Committee shall after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:
- maximum value of transactions that can be allowed in a year
- maximum value per transaction which can be allowed
- extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval
- review, at such intervals as the Audit Committee may deem fit; related party transaction entered into by the company under each of approval made
- transactions which cannot be subject to the Omnibus by the approval Audit Committee
- The Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –
- Repetitiveness of the transactions (in past or future)
- Justification for the need of omnibus approval
- Omnibus approval shall be valid for one financial year and shall require fresh approval after the expiry of such financial year.
- Audit Committee shall after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:
2.1. What if the approval is not taken by the Audit Committee:
When the transaction involves a sum not exceeding one crore rupees and is entered into by a director or officer of the company without obtaining the approval of the Audit Committee, the same can be ratified by the Audit Committee within three months from the date of such transaction.
2.2. What if the contract/arrangement is not ratified within three months?
A contract or arrangement that is not ratified within three months is voidable at the discretion of the Board or shareholders as the case maybe.
2.3. Consequences of not complying the above provisions:
Noncompliance of the provisions as per Section 177 of the Audit Committee:
- company shall be liable to a penalty of five lakh rupees and
- every officer of the company who is in default shall be liable to a penalty of one lakh rupees.
G. Importance of transfer pricing under RPT?
Transfer pricing is required in situations where associated enterprises engage in cross-border transactions, such as the sale of goods or services, the provision of financing, or the transfer of intangible assets. The purpose of transfer pricing in these situations is to ensure that the price charged for the transaction is consistent with the arm’s length principle.
Arm’s length principle states that:
- The price involved between related parties shall be same as they are for any outside person or generic person.
- Auditors suggest transfer pricing when RPTs are involved because it is an important aspect of financial reporting and tax compliance. It is important for auditors to ensure that the prices charged between related parties are in line with the arm’s length principle.
H. Disclosures under the Companies Act, 2013:
- Disclosure of RPTs in mandatory in the Board Report as per Section 134 of the Companies Act 2013 in the Form AOC-2
- Disclosure of the interest by the director in other entities is mandatory under section 184
I. Disclosures as per Indian Accounting Standards
Companies are required to disclose certain information about RPTs in their financial statements, some of the disclosures to be made:
- Nature of relationship
- Description of transactions
- Amounts due to and from related parties
- Pricing policies etc.
After taking into consideration the consequences of contravening the provisions of Companies Act, 2013 and the significance of RPTs, it is strongly suggested to comply with the aforesaid provisions.
If you are looking for compliance support or would like to have more details on RPTs, please reach out to our product head at vaishali@simplybiz.in or simplycorp@simplybiz.in. We will be happy to help you.
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