Indian Legislature has paid special attention to Related Parties and their Transactions with Companies in order to avoid undue advantage taken by the management resulting in loss or injustice to Shareholders, i.e., the Owners of the Company.
Provisions have been made under various acts in order to ensure proper Compliances and Disclosures of Related Party Transactions so that no undue benefit arises from the same by causing harm to the Shareholders or any Third Party.
Who is a Related Party ?
Related Parties have been defined in detail under various Acts as per the requirements and scope under them. Following are some of the definitions of a ‘Related Party’:-
As per Section 2(76) of Companies Act, 2013:
Related Party, with reference to a Company, means –
a. A director or his relative;
b. A key managerial personnel or his relative;
c. A firm, in which a director, manager or his relative is a partner;
d. A private company in which a director or manager or his relative, is a member or director;
e. 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;
f. 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;
g. Any person on whose advice, directions or instructions a director or manager is accustomed to act;
h. Any company which is
- a holding, subsidiary or an associate company, or
- a fellow subsidiary; or
- an investing Company or the venturer of the Company
i. Such other persons as may be prescribed
Where, following shall be considered as ‘Relative’ –
(1) Father (including step-father)
(2) Mother (including step-mother)
(3) Son (including step-son)
(4) Son’s wife
(5) Daughter
(6) Daughter’s husband
(7) Brother (including step-brother)
(8) Sister (including step-sister)
Further it is to be noted that as per MCA Notification dated 5/6/2015, for the purposes of Section 188 of the Act, a holding Company, Subsidiary Company, fellow subsidiaries and associate companies shall not be considered as related parties to a Private Limited Company and hence they shall be exempted from compliances to be followed under Section 188.
As per Accounting Standard 18:
Related Party shall be as follows –
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.
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 such individual; [Shareholding SI = 20% or more Voting Power]
d. Key Management Personnel and relatives of such personnel; [KMP = MD, WTD and any persons in accordance with whose directions or instructions the Board is accustomed to act.] {Non-Executive Directors are not considered as KMP}
e. Enterprises over which any person described in (c) or (d) is able to exercise significant influence;
As per Indian AS-24:
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; or
(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 applies:
(iv) 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).
(v) 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).
(vi) Both entities are joint ventures of the same third party.
(vii) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
(viii) 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.
(ix) The entity is controlled or jointly controlled by a person identified in (a).
(x) 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).
Following shall not be considered as Related Parties as per Accounting Standards:
a. Two entities shall not be considered as Related Parties merely because they have common Directors or KMPs.
b. Two Joint Ventures shall not be considered as Related Parties simply because they share joint control of a Joint Venture.
c. Providers of finance, trade union, public utilities or government departments, simply by virtue of their normal dealings.
d. Major Customer, franchisor, distributor or agent, simply by virtue of resulting economic dependence.
As per SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
“Related Party” Means a related party as defined under sub-section (76) of section 2 of the Companies Act, 2013 or under the applicable Accounting Standards.
As per Income Tax Act, 1961:
The term ‘Relative’ in relation to an individual has been defined under sub-section (41) of Section 2, as the husband, wife, brother or sister or any lineal ascendant or descendant of that individual.
Further, Section 40A(2)(b) defines “Related Parties and its close associates” as follows:
(A) In case individual is an assessee, relative of the individual;
(B) In case assessee is HUF/ Firm/ Company/ Association of Person any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member;
(C) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;
(D) a company, firm, association of persons or Hindu undivided family having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member or any other company carrying on business or profession in which the first mentioned company has substantial interest;
(E) a company, firm, association of persons or Hindu undivided family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;
(F) any person who carries on a business or profession,—
(a) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or
(b) where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person.
Explanation.—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if,—
in a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; and
in any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession.
As per Section 5(24) of the Insolvency and Bankruptcy Code, 2016:
Related Party, in relation to a Corporate Debtor, means –
a. A director or partner of the corporate debtor or a relative of a director or partner of the corporate debtor;
b. a key managerial personnel of the corporate debtor or a relative of a key managerial personnel of the corporate debtor;
c. a limited liability partnership or a partnership firm in which a director, partner, or manager of the corporate debtor or his relative is a partner;
d. a private company in which a director, partner or manager of the corporate debtor is a director and holds along with his relatives, more than two per cent. of its share capital;
e. a public company in which a director, partner or manager of the corporate debtor is a director and holds along with relatives, more than two per cent. of its paid- up share capital;
f. anybody corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;
g. any limited liability partnership or a partnership firm whose partners or employees in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;
h. any person on whose advice, directions or instructions, a director, partner or manager of the corporate debtor is accustomed to act;
i. a body corporate which is a holding, subsidiary or an associate company of the corporate debtor, or a subsidiary of a holding company to which the corporate debtor is a subsidiary;
j. any person who controls more than twenty per cent. of voting rights in the corporate debtor on account of ownership or a voting agreement;
k. any person in whom the corporate debtor controls more than twenty percent of voting rights on account of ownership or a voting agreement;
l. any person who can control the composition of the board of directors or corresponding governing body of the corporate debtor;
m. any person who is associated with the corporate debtor on account of-
(i) participation in policy making processes of the corporate debtor; or
(ii) having more than two directors in common between the corporate debtor and such person; or
(iii) interchange of managerial personnel between the corporate debtor and such person; or
(iii) provision of essential technical information to, or from, the corporate debtor;
What are Related Party Transactions ?
Any transactions entered between the Company and its Related Party shall be considered as Related Party Transactions. However, various laws have specified the transactions which shall be considered as Related Party Transactions under their ambit. Following shall be considered as Related Party Transactions under various Acts:
As per Section 188 of the Companies Act, 2013:
Following are the Specified Contracts between A Company and Related Party –
a. Sale, purchase or supply or any goods or materials.
b. Selling, buying property of any kind.
c. Leasing of property of any kind.
d. Availing or rendering of any services.
e. Appointment of agent for purchase or sale of goods, materials, services or property
f. Appointment to any office or place of profit in the company/Associate Company /Subsidiary Company.
g. Underwriting of securities.
As per Regulation 2(ZC) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
Related Party Transactions shall be Transfer of resources, services or obligations between the Company and Related Party regardless of whether price is charged or not.
As per Accounting Standard – 18:
Related Party Transactions shall be Transfer of resources or obligations between the Company and Related Party regardless of whether price is charged or not.
As per Indian Accounting Standard -24:
Related Party Transactions shall be Transfer of resources, services or obligations between the Company and Related Party regardless of whether price is charged or not.
Compliances to be followed under Companies Act, 2013
All Related Party Transactions u/s 188 require approval by Board of Directors of the Company. Audit Committee shall approve all transactions with Related Parties, wherever appointed. The Committee may also make Omnibus Approval for Related Party Transactions.
A company shall not enter into a contract or arrangement with any related party except with the prior approval of members of the company by Ordinary Resolution (Rule 15(3)) for the following transactions:
a. Sale, purchase or supply of any goods or materials directly or through appointment of agents amounting to 10% 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 agents amounting to 10% or more of Net worth of the company.
c. leasing of property of any kind amounting to 10% or more of turnover of the company.
d. availing or rendering of any services directly or through appointment of agents amounting to 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 at a monthly remuneration exceeding two and 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.
Shareholder’s approval shall not be necessary for transactions entered into between a Holding Company and its Wholly Owned Subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
Further, Related Party shall not be entitled to vote on Members’ Resolution. If 90% of members are either related parties or relatives of Promoters, Related Parties can vote on Resolution. Section 188 shall not apply to transactions entered in ordinary course of business which are on Arm’s length basis.
Compliances to be followed under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
As per Regulation 4(2)(f)(ii)(6):
There is no specific requirement of taking approval of from the Board of Directors for Related Party Transactions. However, the key function of the Board is to monitor and manage potential conflict of interest including abuse in Related Party Transactions.
As per Regulation 23:
All related party transactions shall require prior approval of the audit committee.
Audit committee may grant omnibus approval for related party transactions proposed to be entered into by the listed entity subject to the following conditions:
a. the audit committee shall lay down the criteria for granting the omnibus approval in line with the policy on related party transactions of the listed entity and such approval shall be applicable in respect of transactions which are repetitive in nature;
b. the audit committee shall satisfy itself regarding the need for such omnibus approval and that such approval is in the interest of the listed entity;
c. the omnibus approval shall specify:
(i) the name(s) of the related party, nature of transaction, period of transaction, maximum amount of transactions that shall be entered into,
(ii) the indicative base price / current contracted price and the formula for variation in the price if any; and
(iii) such other conditions as the audit committee may deem fit; Provided that where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may grant omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.
d. the audit committee shall review, at least on a quarterly basis, the details of related party transactions entered into by the listed entity pursuant to each of the omnibus approvals given.
e. Such omnibus approvals shall be valid for a period not exceeding one year and shall require fresh approvals after the expiry of one year.
Following Transactions shall not require approval of Shareholders:
a. Transactions entered into between two government companies;
b. Transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
Related Party Transaction Policy under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
Following points shall be kept in mind while formulating the Policy on Related Party Transactions:
Materiality of Related Party Transactions
As per Regulation 23(1), the listed entity shall formulate a policy on materiality of related party transactions and on dealing with related party transactions including clear threshold limits duly approved by the board of directors and such policy shall be reviewed by the board of directors at least once every three years and updated accordingly.
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 a financial year, exceeds ten percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
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.
Omnibus Approval of Related Party Transactions
As per Regulation 23(3)(a), Audit Committee shall lay down the criteria for granting the omnibus approval in line with the policy on related party transactions.
Disclosure on Website
As per Regulation 46(2)(g), Listed entity shall disseminate Policy on Dealing with Related Party Transactions under a separate section on its website.
Conclusion
The main objective of the Legislature for forming such stringent compliances and disclosure rules is to ensure that Related Party Transactions are entered into at a Fair Price, i.e., at arm’s length price and if such transactions are entered into at a price lower or higher than Fair Price, proper disclosures are made so that the Shareholders of the Company are aware of the Company’s dealings.
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