Company is an entity independent of its shareholders and board of directors. The company runs out of funds invested by shareholders. However, there is always a possibility that the company’s management or internal team may cause undue benefit to any of its relatives by entering into unfair agreements with them like selling goods at an undue low price or acquiring goods at undue high price.
Therefore, it is important for the shareholders to know what all transactions have been entered into with related parties during the year and at what price, and whether the such price is fair or not. Therefore, necessary provisions are provided under most of the Acts to deal with such transactions such as Transfer pricing norms under Income Tax, Related Party disclosure under Accounting standard, Section 188 of Companies Act, 2013, SEBI ( Listing Obligations and Disclosure Requirements), etc.
Any contract or arrangement entered into with a related party is treated as a related party transaction under the Companies Act, 2013. The Ministry of Corporate Affairs and SEBI allows related party transactions to enter into the normal course of business at a price that is applicable to other parties. However, transactions not at arm’s length price require approval of the audit committee, board, and shareholders’ approval. Therefore, it becomes essential to have internal controls within an organization to prevent abusive related party transactions and establish a robust mechanism of approvals and disclosures.
This article will give you insights into the identification, materiality thresholds, approvals, and disclosures of related party transactions given under the Companies Act, 2013 and Securities, and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (hereinafter referred to as “Listing Regulations”).
1. Meaning of related party
To identify whether an individual or entity falls within the realm of a related party or not, one must know who all are covered in the term related party.
Term related party is defined u/s 2(76) of Companies Act, 2013 and under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. As per Section 2(76) of the Companies Act, With reference to any company, the following shall be the related party:
- A director or his relative;
- Key managerial personnel or his relative;
- Any firm: In which a director, manager, or relative is a partner;
- Private Limited company: In which a director or manager or his relative is a member or director
- Private Limited Company in which a director or manager:
- Is a director or
- Holds, along with his relatives, more than 2% of the paid-up share capital of the company.
- Anybody corporate whose board of directors, managing director, or manager is accustomed to acting in accordance with the advice, directions, or instructions (except those given in a professional capacity) of a director or manager;
- Any person on whose advice, directions, or instructions (except those given in a professional capacity) a director or manager is accustomed to act.
- A holding, subsidiary, or an associate company; or
- Another subsidiary Company of the holding company. For E.g. A limited is a holding company of B Limited and C Limited. In that case, B Limited and C limited will be related parties.
- Anybody corporate who has invested in a company i.e. an investing company or the venture company.
- Prescribed person i.e. a director other than an independent director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party.
Further, as per Section 2(1)(ZB) of the SEBI Act, in addition to the above-mentioned parties, the following parties are also considered related parties:
- All members of the promoter and promoter group of a company irrespective of their shareholding with effect from April 1, 2022.
- Persons or entities holding 20% (10% w.e.f 1st April 2023) or more of the equity shares, either directly or on a beneficial interest basis of a company, at any time during the immediately preceding financial year.
“Relative” means anyone who is related to another, if—
- They are members of a Hindu Undivided Family;
- They are husband and wife; or
- One person is related to the other as father stepfather, mother stepmother, brother including step brother, sister including step-sister, son including stepson, son’s wife, daughter, and daughter’s husband.
2. Identifying Related party transactions
As per Section 188 of the Companies Act, 2013, the following transactions are categorized as related party transactions when entered into with a related party by any company—
- Sale, purchase, or supply of any goods or materials;
- Selling or otherwise disposing of, or buying, property of any kind;
- Leasing of property of any kind;
- Availing or rendering of any services;
- Appointment of any agent for purchase or sale of goods, materials, services, or property;
- Such related party’s appointment to any office or place of profit in the company, its subsidiary company, or associate company; and
- Underwriting the subscription of any securities or derivatives thereof, of the company.
In addition to the above, as per Regulation 2(1)(zc) of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, related party transaction means a transfer of resources, services, or obligations between:
- a listed entity or any of its subsidiaries on one hand and a related party of the listed entity or any of its subsidiaries on the other hand; or
- a listed entity or any of its subsidiaries on one hand, and any other person or entity, on the other hand, the purpose, and effect of which is to benefit a related party of the listed entity or any of its subsidiaries
3. Approvals required for related party transactions
Following approvals are required in terms of provisions of Section 188 of Companies Act, 2013 read with Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 and listing regulations:
(i) Board of directors’ approval
- No related party transaction shall be entered by the company without prior approval of the Board of Directors.
- However, no such approval is required when a transaction is entered into by the Company in the ordinary course of business at arm’s length price.
(ii) Shareholders’ approval
- Where a related party transaction does not occur in the normal course of business or is not at an arm’s length price and the value of the transaction exceeds the materiality threshold under the Companies Act, 2013, shareholders’ approval via resolution is required.
- In the case of a listed company, where a related party transaction exceeds the materiality threshold under listing regulations will also require shareholders’ approval.
(iii) Audit Committee’s approval
- As per Regulation 18 of SEBI (Listing Obligations and disclosure requirement) regulations, 2015, every listed company is required to form an audit committee consisting of a minimum of 3 directors.
- At least 2/3rd of the members of the audit committee shall be independent.
- All members of the audit committee shall be financially literate and at least one member shall have accounting or related financial management expertise
- In the case of listed companies, prior approval of the audit committee is required in the following cases:
- a related party transaction to which the subsidiary of a listed entity is a party but the listed entity is not a party and the value of such transaction (whether entered into individually or taken together with previous transactions) exceeds 10% of the annual consolidated turnover, as per the last audited financial statements
- with effect from April 1, 2023, a related party transaction to which the subsidiary of a listed entity is a party but the listed entity is not a party if the value of such transaction whether entered into individually or taken together with previous transactions during a financial year, exceeds 10% of annual standalone turnover.
(iv) Exceptions for approvals
- Approval of the board of directors and prior approval of the shareholders is not required when such related party transaction is in the ordinary course of its business and on an arm’s length basis.
- prior approval of the shareholders and audit committee of a listed entity will not be required if the subsidiary of such listed entity is itself a listed company to which the RPT framework under the listing regulations applies
4. Materiality threshold for related party transactions
Prior approvals are necessary in case of related party transactions. However, if approval is required in all the case then carrying out business will be difficult, Therefore, the Companies Act and SEBI have granted some threshold relaxations below which no approval is required from shareholders.
Following are the exemption thresholds:
- Companies Act, 2013
|(a) sale, purchase, or supply of any goods or materials.||(a)10% or more of the turnover of the company.|
|(b) selling or otherwise disposing of or buying property of any kind, directly or through the appointment of an agent.||(b) 10% or more of the turnover of the company.|
|(c) leasing of any kind of property.||(c) 10% or more of the turnover of the company.|
|(d)availing or rendering of any services, directly or through the appointment of an agent.||(d) 10% 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.||(e)Monthly remuneration exceeding two and a half lakh rupee.|
|(f) underwriting the subscription of any securities or derivatives.||(f) one percent of the net worth of the company.|
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
- Under SEBI, a transaction with the related party will be considered as material if transactions entered into individually or taken together with previous transactions during a financial year exceeds, lower of the followings:
- INR 1000 Crores or
- 10% of consolidated turnover of the listed entity as per the last audited financial statements
- Further, 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 5% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
5. Disclosures for related party transactions
(i) Disclosures for related party transactions in Board’s report
- Every contract or arrangement entered into by the company shall be referred to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement.
- The particulars of related party transactions which are not on an arm’s length price and material-related party transactions which are on arm’s length price will be reported in AOC-2.
(ii) Disclosures for related party transactions In the register of contracts or arrangements
Every company is required to record details of related party transactions in the register in Form MBP-4.
(iii) Disclosures for related party transactions to stock exchanges for listed companies
A listed entity is required to disclose details of related party transactions on a consolidated basis in a prescribed format, to the stock exchanges, and on its website, within 30 days (15 days from 1st April 2022 and simultaneously with the release of financial results from 1st April 2023) from the date of publication of the standalone and consolidated financial results for the half year.
(iv) Disclosures for related party transactions in the annual report for listed companies
A listed company is required to make the disclosures for related party transactions in an annual report in the corporate governance section.
6. Annual action points for related party transactions
- Obtain disclosure of interest by directors or key managerial personnel on their appointment or any change thereafter at board meetings.
- Obtain a list of related parties from subsidiaries (ies) of listed entities.
- Listed companies should formulate a policy on related party transactions containing processes to identify, review and approve related party transactions.
- Monitor and update regularly the policy on related party transactions.
- Disclose policy on related party transactions on the website of the company.