With growing participation of investors and other stakeholders in companies, the question of transparency in arrangements with related parties has often been a topic of much debate and discussion. With the objective to usher increased degree of transparency in such transactions, to determine the exact financial position of the entity, Section 188 was introduced in the Companies Act, 2013 placing onus on the Board of Directors to review, approve, explain and recommend such arrangements to shareholders for seeking their approval. In addition, a listed company would need to comply with the disclosure and approval requirements under SEBI (Listing Obligation and Disclosure Requirement) Regulation 2015 (‘LODR’).
Considering the wide coverage of Related Party Transaction in the Companies Act, 2013 (the Act), the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, (LODR) and the applicable accounting standards (AS 18 or Ind AS 24 etc.), it is suggested to strengthen the identification and monitoring of Related party Transactions (‘RPTs’), a framework outlining the roles and responsibilities, disclosure requirements, communication and monitoring requirements would need to be defined.
This article provides a recommendatory framework, which may be adopted with suitable modification of your requirement. Before starting to do the compliances of Related Party Transactions, a person must be aware about all the legislations, which govern the related party transactions. The following legislations govern the related party transactions: -
- Companies Act, 2013
- SEBI (Listing Obligation and Disclosure Requirement) Regulation 2015
- Accounting standards
COMPANIES ACT, 2013:
Section 2(76), 166, 177, 184, 188 and 189 of the Companies Act, 2013 regulate the Related Party Transactions.
Identification of Related Parties as per Companies Act.
Before entering into any transaction with the related party, it is important to identify the Related Parties (as defined under section 2(76) of the Companies Act, 2013).
Section 2(76) of the Act reads as follow:
Related party", with reference to a company, means-
- a director or his relative;
- a key managerial personnel or his relative;
- a firm, in which a director, manager or his relative is a partner;
- a 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 per cent of its paid-up share capital;
- 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;
- 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 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;
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.
* In case of private company - Sub-clause (viii) of clause 76 of Section 2, Shall not apply with respect to section 188.
ix. such other person as may be prescribed; (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).
First test for related party transaction is to check/ensure whether the target entity/person is related party or not. If, a target entity/person which falls in any of the aforesaid category, it shall be related party and a transaction with these parties shall be replated party transaction. One who wants to enter into a transaction has to ensure whether the target entity/person is related party or not. Once it is defined that a company is entering into a transaction with related party in that case the company has to ensure the different level of compliances.
To ascertain the related parties to the Company, a Company may create data base of related parties to the Company. It can be prepared on the basis of the declarations received from the Directors / KMPs, review of structure and subsequent changes as may be notified, the Company may devise a mechanism to maintain a consolidated list of related parties. The database should ideally capture all the information as stated in section 2(76).
Classification of Related Party Transactions as per Companies Act:
RPTs specified under Section 188(1) of the Act:
Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to-
- 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:
Provided that no contract or arrangement, in the case of a company having a paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, shall be entered into except with the prior approval of the company by a resolution:
Provided further that no member of the company shall vote on such resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party:
Provided also that nothing contained in the second proviso shall apply to a company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties:
Provided also that nothing in this sub-section shall apply to any transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis.
Provided also that the requirement of passing the resolution under first proviso shall not be applicable 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:
Explanation. - In this sub-section, -
A. the expression “office or place of profit” means any office or place-
- where such office or place is held by a director, if the director holding it receives from the company anything by way of remuneration over and above the remuneration to which he is entitled as director, by way of salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
- where such office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;
B. the expression “arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.
Threshold limits for RPTs for which prior approval of the members of the Company is required:
|
S. No. |
Specified Transaction |
Thresholds |
|
1 |
sale, purchase or supply of any goods or materials, directly or through appointment of agent |
Amounting to 10% or more of turnover of the Company or Rs.100 Crore, whichever is lower |
|
2 |
selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent |
Amounting to 10% or more of net worth of the Company or Rs.100 Crore, whichever is lower |
|
3 |
leasing of property of any kind |
Amounting to 10% or more of net worth of the Company or 10% or more of turnover of the Company or Rs. 100 Crore, whichever is lower |
|
4 |
availing or rendering of any services, directly or through appointment of agent |
Amounting to 10% or more of turnover of the Company or Rs.50 Crore, whichever is lower |
|
5 |
such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company |
Exceeding Rs.2,50,000/- per month |
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6 |
remuneration for underwriting the subscription of any securities or derivatives thereof, of the company |
Exceeding 1% of net worth |
Explanation. - The limits specified in point no. 1 to 4 shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
Identification of Related Parties as per LODR:
Definition of Related parties for Listed entities is little different from other companies. As per regulation 2(zb) of the 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:
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 be deemed to be a related party.
Provided further that this definition shall not be applicable for the units issued by mutual funds which are listed on a recognised stock exchange(s);
Classification of Related Party transactions as per LODR:
“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:
Provided that this definition shall not be applicable for the units issued by mutual funds which are listed on a recognised stock exchange(s);
The Listed entity shall formulate the Policy on materiality of Related Party Transactions and also 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:
Material Transaction: - Transaction with a related party shall be considered material if the transaction / transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds 10% of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
Notwithstanding the above, 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 two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
- Prior approval of the Audit Committee is required for all related party transactions. However, audit committee may grant omnibus approval for related party transactions proposed to be entered into by the company subject to the conditions laid down under Regulation 23 (3) (a) to (e) of LODR.
- Any material transaction to be entered by the company with any related party shall be approved by the shareholders of the Company and all related parties shall abstain from voting on such resolutions whether the entity is a related party to the particular transaction or not;
Provided that the requirements specified under regulation 23(4) shall not apply in respect of a resolution plan approved under section 31 of the Insolvency Code, subject to the event being disclosed to the recognized stock exchanges within one day of the resolution plan being approved;
No such approval is required for the transactions entered into between
- Two government companies;
- 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.
Approval Procedure for Related Party Transactions as per Companies Act and SEBI (LODR):
(A) Audit Committee approval:
|
S. No. |
Unlisted Entities (As per Companies Act, 2013) |
Listed Entities As SEBI (LODR) |
|
|
|
Identify the Related Parties to the Company |
As defined under Section 2 (76) |
As pre regulation 2(zb). i.e. Section 2 (76) or under applicable Accounting Standards |
|
|
Transaction required approval of the Audit Committee |
Approval of the Audit Committee shall be required for all the transaction with related parties. Any transaction, other than transactions referred to in section 188, and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board. Any transaction involving any amount not exceeding one crore rupees is entered into 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 the related party to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it. Provisions of the section 177(4) (iv) shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company. |
Prior approval of the Audit Committee is required for all related party transactions. |
|
|
Omnibus approval |
No Omnibus approval shall be granted for the transaction related to selling or otherwise dispose of the undertaking of the Company. |
|
|
(B) Process for Board and / or Members/ Shareholders’ approval |
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(Except in case of private company or A company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties).
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|
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(C) Approval in the event of any change / modification in the transaction as approved:
- In case of any change or modification in a transaction / contract / arrangement with a related party, prior approval for the change should be obtained from the original approval authority
- Following should be considered while obtaining approval for the change:
- Impact of the change on the arm’s length pricing, and consequent Board approval, if it is required
- If post the change, aggregate of the value of the transaction is likely to reach/cross at the threshold limit for material transaction and/or limits as mentioned under Rule 15(3) of Companies (Meetings of Board and its Powers) Rules, 2014 then in such event’s shareholders’ approval will be required.
(D) Other than the approval of the Audit Committee (required u/s 177 of the Act), no approval shall be required for transactions to be entered by the Company with related parties which are in the ordinary course of business and on arms’ length basis.
Noting of the contract/arrangement: Enter the details of RPTs in the register as prescribed under Section 189 of the Act read with rules made there under and put the same before the next Board meeting for signature of all directors present thereat.
Disclosure requirements:
The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-
- the name of the related party and nature of relationship;
- the nature, duration of the contract and particulars of the contract or arrangement;
- the material terms of the contract or arrangement including the value, if any;
- any advance paid or received for the contract or arrangement, if any;
- the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
- whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
- any other information relevant or important for the Board to take a decision on the proposed transaction.
The explanatory statement to be annexed to the notice of a general meeting convened pursuant to section 101 shall contain the following particulars, namely: -
- name of the related party;
- name of the director or key managerial personnel who is related, if any;
- nature of relationship;
- nature, material terms, monetary value and particulars of the contract or arrangements;
- any other information relevant or important for the members to take a decision on the proposed resolution.
Disclosure in the Board’s Report (in Form AOC-2) which inter alia includes:
- reference of contract or arrangement with related parties;
- justification for entering into such a contract or arrangement; and
- additional disclosures as per the Accounts Rules.
Disclosure as per SEBI (LODR)
- The listed entity shall submit within 30 days from the date of publication of its standalone and consolidated financial results for the half year, disclosures of related party transactions on a consolidated basis, in the format specified in the relevant accounting standards for annual results to the stock exchanges and publish the same on its website;
- policy on dealing with RPTs to be disclosed on website and a web link thereto shall be provided in the annual report;
- details of all material transactions with related parties shall be disclosed quarterly along with the compliance report on corporate governance.
Disclosure as per Accounting Standards
- name of related party;
- nature of relationship;
- nature of the transaction;
- amount of transaction
- volume of the transaction;
- any other elements necessary for understanding the financial statements;
- amounts outstanding and provision for doubtful debts;
- amounts written off or written back; and
- remuneration paid to KMPs.
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