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:
- Un director o su familiar;
- Personal directivo clave o su familiar;
- Cualquier firma en la que un director, gerente o familiar sea socio;
- Sociedad de responsabilidad limitada privada: en la que un director, gerente o su familiar sea miembro o director;
- Sociedad de responsabilidad limitada privada en la que un director o gerente:
- Sea director o
- Posea, junto con sus familiares, más del 2% del capital social desembolsado de la empresa.
- Cualquier entidad corporativa cuyo consejo de administración, director gerente o gerente esté acostumbrado a actuar de acuerdo con el asesoramiento, las directrices o las instrucciones (excepto aquellas dadas en capacidad profesional) de un director o gerente;
- Cualquier persona bajo cuyo asesoramiento, directrices o instrucciones (excepto aquellas dadas en capacidad profesional) un director o gerente esté acostumbrado a actuar;
- Una sociedad matriz, subsidiaria o asociada; o
- Otra sociedad subsidiaria de la sociedad matriz. Por ejemplo, A Limited es la sociedad matriz de B Limited y C Limited. En ese caso, B Limited y C Limited serán partes vinculadas.
- Cualquier entidad corporativa que haya invertido en una empresa, es decir, una sociedad inversora o la sociedad de riesgo.
- Persona prescrita, es decir, un director que no sea un director independiente o personal directivo clave de la sociedad matriz, o su familiar con referencia a una empresa, se considerará parte vinculada.
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:
- Todos los miembros del promotor y del grupo promotor de una empresa, independientemente de su participación accionarial, con efecto a partir del 1 de abril de 2022.
- Personas o entidades que posean el 20% (10% a partir del 1 de abril de 2023) o más de las acciones ordinarias, ya sea directamente o sobre una base de interés beneficiario de una empresa, en cualquier momento durante el ejercicio financiero inmediatamente anterior.
“Relative” means anyone who is related to another, if—
- Son miembros de una Familia Indivisa Hindú;
- Son marido y mujer; o
- Una persona está relacionada con la otra como padre, padrastro, madre, madrastra, hermano (incluyendo medio hermano), hermana (incluyendo media hermana), hijo (incluyendo hijastro), esposa del hijo, hija y esposo de la hija.
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—
- Venta, compra o suministro de cualquier bien o material;
- Venta o disposición de otro modo, o compra, de propiedad de cualquier tipo;
- Arrendamiento de propiedad de cualquier tipo;
- Prestación o recepción de cualquier servicio;
- Nombramiento de cualquier agente para la compra o venta de bienes, materiales, servicios o propiedades;
- Nombramiento de dicha parte vinculada para cualquier cargo o puesto de beneficio en la empresa, su sociedad subsidiaria o sociedad asociada; y
- Aseguramiento de la suscripción de cualquier valor o derivado del mismo, de la empresa.
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:
- una entidad cotizada o cualquiera de sus subsidiarias, por una parte, y una parte vinculada de la entidad cotizada o cualquiera de sus subsidiarias, por otra; o
- una entidad cotizada o cualquiera de sus subsidiarias, por una parte, y cualquier otra persona o entidad, por otra, cuyo propósito y efecto sea beneficiar a una parte vinculada de la entidad cotizada o de cualquiera de sus subsidiarias.
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:
- Ley de Sociedades de 2013
| Transaction |
Threshold Limit |
| (a) Sale, purchase, or supply of any goods or materials. |
10% or more of the turnover of the company. |
| (b) Selling, disposing, or buying property of any kind (direct or through agent). |
10% or more of the turnover of the company. |
| (c) Leasing of any kind of property. |
10% or more of the turnover of the company. |
| (d) Availing or rendering of any services (direct or through agent). |
10% or more of the turnover of the company. |
| (e) Appointment to any office or place of profit in the company, its subsidiary, or associate. |
Monthly remuneration exceeding ₹2.5 lakh. |
| (f) Underwriting the subscription of any securities or derivatives. |
1% 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.
