Related Party Transactions

In business environment it is impossible to avoid business transactions with related parties (RPT).
In one way or the other there would be a related person, at least in a few transactions for every
company. Therefore, the Companies should be mindful of regulatory aspect governing RPT under
the ambit of Companies Act, 2013 (the Act), Income Tax Act, 1961 and transfer pricing guidelines
thereunder. All RPTs are not prohibited but they are regulated and subject to scrutiny the Board /
Audit Committee, Shareholders and taxation authorities. The erstwhile requirement of obtaining
Regional Directors approval for entering into RPT has been done away with but a higher
obligation has been imposed upon the Board to ensure that RPT are entered in accordance with
the approval of the Board and reported in the Financial Statements and Directors Report. The
provisions relating to RPT apply to every company, be it a private, unlisted public, listed public or
foreign company.
In order to understand Related Party Transaction (RPT), it is essential to first understand the
meaning of Related Party, from the perspectives of listed company, unlisted public companies
and private companies. The Listing Agreement defines Related Party as defined in Sec.2(76) of
the Act. Therefore, there is no difference in definition of related party between Unlisted Public
Companies vis--vis Listed Company. However, for Private companies certain exemptions have
been issued.
Sec. 2(76) of the Act defines Related Party as follows:
Related Party, with reference to a Company, means:
(i)

a director or his relative;

(ii)

a key managerial personnel or his relative;

(iii)

a firm, in which a director, manager or his relative is a partner;

(iv)

a private company in which a director or manager or his relative1 is a member or director;

(v)

a public company in which a director or manager is a director and2 holds along with his
relatives, more than two per cent. of its paid-up share capital;

(vi)

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;

(vii)

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 company which is

(A) a holding, subsidiary or an associate company of such company; or

1 Amended by Companies (Removal of Difficulties) Sixth Order dated July 24, 2014
2 Or has been replaced with And by Companies (Removal of Difficulties) Fifth Order published on
July 9, 2014

Related Party Transactions

(B) a subsidiary of a holding company to which it is also a subsidiary;
In the case of a Private Company, sub-clause (viii) shall not apply unless there is a common
director between the Company and the holding, subsidiary, associate or a co-subsidiary to
such company.
(ix)

A director3 or KMP of the holding company of such company or his relative;

These can be easily understood with the help of following diagram presentation.
Case 1 : Director / KMP or his relatives

Mr. C

Mr. C

Director / KMP

Relative

Partner
PQR
firm

Partner

Relative

Mr. A

Case 2 Firm

Mr. D

Director / Manager

Co.

Compan
y

Case 3 : Private Company

Case 4 : Public Company

Mr. C

Shareholder*

Director / Member

Mr. A

Director / Member

XYZ
Ltd.

XYZ
Ltd.

Director *

Relative

Relative

Mr. C

Mr. D

Director / Manager
Compan
y

Director / Manager

*Director along with his relatives having more

than 2% of its paid-up share capital

Compan
y

Case 6 : Accustomed to act - 2

Any Body

Case 5: Accustomed to Act 1

XYZ
Ltd.

Any

Any
Person

Director / Manager

Mr. A

Compan
y

Director / Manager

Person*

Compan
y

Corporate*

3 A director shall be a director other than independent director on notification of Companies

(Specification of Definition) Amendment Rules, 2014 dated July 17, 2014 in the Official Gazette
Mr. A

Related Party Transactions

*whose Board of Directors, managing director

*under whose advice, directions or instructions

or

a director or manager is accustomed to act

manager

is

accustomed

to

act

in

accordance with the advice, directions or

instructions of a director or Manager
Case 7:

Case 8
Holding Co

Relative Mr. C

Holding Co.

XYZ Director / KMP Mr. B

Ltd.

Compan
y

Compan
y

Associate
Co.

Subsidiary
Co.

Fellow
Subsidiary

Subsidia
ry

Note:
For Private companies under case 8, parties shall be considered as related party if there are
common directors in Company and Associate Co. / Subsidiary Co. / Fellow Subsidiary / Holding
Co.
Covered transaction

Holding structure

After having understood the meaning of Related Party, it is essential to understand the Related
Party transactions which the Act envisages to regulate and are subject to approval of the Board /
Shareholders.
Transactions covered under Related Party Transactions (RPT) ambit
The Act specifies that all related party transactions which are not in the ordinary course of
business or which are not entered into on arms length basis are subject to the approval of
Board / Audit Committee and members of the Company. Sec. 188(1) specifies the following
transactions which are treated as related party transactions:. Further, Rule 15 of Companies
(Meeting of Board and its Powers) Rules, 2014 specifies ceilings beyond which transactions are

Related Party Transactions

subject to the approval of the shareholders by way of prior approval of shareholders through
ordinary resolution4.
S.

Transactions

Ceilings*

No.
1

Sale, purchase or supply of any goods or materials

10% of the turnover or

Rs.100

crores,

whichever is lower
2

Selling or otherwise disposing of, or buying, property of any

10% of net worth of the

kind;

Company
crores,

or

Rs.100

whichever

is

lower
3

Leasing of property of any kind;

10% of net worth of the

Company or 10% of the
turnover

of

Company
crores,

or

the
Rs.100

whichever

is

lower
4

Availing or rendering of any services;

10% of the turnover of

the Company or Rs.50
crores,

whichever

is

lower
5

Appointment of any agent for purchase or sale of goods,

10% of the turnover or

materials, services or property;

Rs.100

crores,

whichever is lower
6

Such related party's appointment to any office or place of

At

monthly

profit in the company, its subsidiary company or associate

remuneration exceeding

company; and Related party transactions.

Rs.250,000/-

Underwriting the subscription of any new securities or

Exceeding 1% of the net

derivatives thereof, of the company

worth of the Company

*Turnover or Net worth shall be computed on the basis of the audited financial statements of

the preceding financial year.

If the related party transaction exceeds the above ceilings then prior approval of the

shareholders by way of ordinary resolution is required.

No member of the company shall vote on such resolution, to approve any contract or
arrangement which may be entered into the by the company, if such member is a related
party. This requirement is not applicable to a Private Company.

4 Changed from Special Resolution to Resolution by Notification No. GSR 971(E) dated
December 14, 2015 i.e. approval by way of an ordinary resolution of shareholders is required.

Related Party Transactions

In case of wholly owned subsidiary company, the resolution passed by the holding company
shall be sufficient for the purpose of entering into transactions between holding company and

wholly owned subsidiary company.

Prior approval of the board of directors will be required for all transactions that are not in the

ordinary course of business or art not at arms length.

Where any director is interested or concerned 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. In case of Private
companies, interested director, after disclosure of interest, can participate in the Board
Meeting.

Approval of Related Party transactions under Companies Act, 2013

The transactions with related parties which are either
(i)

Not in the ordinary course of business and exceeding the ceilings

(ii)

Not on Arm Length basis and exceeding the ceilings

are subject to the approval of the Board of Directors and prior approval of the shareholders of the
Company by way of ordinary resolution. The transactions which are in the ordinary course of
business and on arm length basis does not require approval of either the Board or the
Shareholders, under Sec. 188 of the Act.

Related Party Transactions

Approval of Related Party transactions under Companies Act, 2013
Private companies perspective
Arms length transaction
means
a
transaction
between
two
related
parties that is conducted
as if they are unrelated, so

Approval for Related

Party Transactions

RPT is at arm's length

basis
and
in
the
ordinary
course
of

Take note at
the Board

RPT is not at arm's

length basis or not in

Not exceeding the

specified limits /

No approval of the
Board
or
Shareholders
is
required

Exceeding the
specified limits /

Boards
approval

Boards
approval

Sharehold
ers
Omnibus Approval of Related Party transactions by Audit Committee
(For Listed and unlisted public companies)
As discussed above, section 188 of the Companies Act, 2013 deals with related party
transactions and requires approval of members by means of an ordinary resolution in case such
transactions are beyond particular thresholds as prescribed by Rule 15 of the Companies
(Meetings of Board and its Powers) Rules, 2014, as amended from to time. Related party
transactions which are in the ordinary course of business and are at arms length are exempted
from such approval requirements.
However, as per Section 177(4)(iv) of the Act, in case of companies which mandatorily need to
have audit committee, audit committee will approve all related party transactions or any
subsequent modification of such transactions with related parties.
Listed companies already had the advantage of omnibus approval policy due to provisions of the
Listing Regulations (and prior to that due to Clause 49), however, certain other public companies

Related Party Transactions

which are also required to have an audit committee (depending upon the criteria as provided by
the rules), did not have the benefit of such omnibus approval policy until the Omnibus Approval
Amendment5, and related party transactions in such companies required approval of the Audit
Committee on case to case basis.
With a view to ease related party transactions and to overcome the difficulty faced by companies
requiring approval of Audit Committee for every related party transaction, the Central
Government has amended the rules to provide for Omnibus Approval Amendment to enable
companies to pursue their related party transactions on a pre-approved basis as per the policy
framed therein for the purpose, unless such transactions are required to be approved otherwise.
Applicability
The omnibus approval route is applicable for following companies which are required to
mandatorily have an audit committee:
(i) Listed Companies;
(ii) Public Companies with a paid-up capital of INR 10,00,00,000 (Indian Rupees Ten Crore) or
more;
(iii)Public Companies having turnover of INR 100,00,00,000 (Indian Rupees One Hundred Crore)
or more; and
(iv) Public Companies having in aggregate outstanding loans or borrowings or debentures or
deposits exceeding INR 50,00,00,000 (Indian Rupees Fifty Crore) or more.
Criteria
The Audit Committee may, after obtaining approval of the Board of Directors, form omnibus
approval policy for transactions that can be foreseen for a financial year. The Audit Committee is
required to inter alia consider below-mentioned parameters for making the omnibus approval
policy:
(i)

maximum value of the transactions, in aggregate, which can be allowed under the
omnibus route in a year;

(ii)

the maximum value per transaction which can be allowed;

(iii)

extent and manner of disclosures to be made to the Audit Committee at the time of
seeking omnibus approval;

(iv)

review, at such intervals as the Audit Committee may deem fit, related party transaction
entered into by the company pursuant to each of the omnibus approval made;

(v)

transactions which cannot be subject to the omnibus approval by the Audit Committee;
and

5 Inserted by Notification No. GSR 971(E) dated December 14, 2015

Related Party Transactions

(vi)

any other conditions as the Audit Committee may deem fit.

Factors to be taken into consideration for omnibus approval policy:

The Audit Committee will need to consider (a) repetitiveness of the transactions (in past or in
future); and (b) justification for the need of omnibus approval, before framing the policy on
omnibus approval i.e. repetitive transactions which are in the interest of the Company. The Audit
Committee will be governed by the mandate of safeguarding the interests of the Company
before framing omnibus approval policy.
Contents of the Omnibus Approval Policy
The omnibus approval policy will need to provide/indicate details like
(i)

name of the related parties[;

(ii)

nature and duration of the transaction;

(iii)

maximum amount of transaction that can be entered into;

(iv)

the indicative base price or current contracted price and the formula for variation in the
price, if any, and

(v)

any other necessary relevant information.

However, where the need for related party transaction cannot be foreseen and aforesaid details
are not available, Audit Committee may provide for approval of such transactions in omnibus
approval policy subject to their value not exceeding Rs. 1,00,00,000 (Indian Rupees One
Crore) per transaction. The transactions related to selling and acquiring of undertakings is not
covered under Omnibus approval route.
Validity of approval
The omnibus approval shall be valid for a period of one financial year and shall require fresh
approval of the Audit Committee after the expiry of financial year.
Governance Structure for Related Party transactions (Listed & Public co. perspective)

Approval for Related

Party Transactions

RPT is at arm's length

basis
and
in
the
ordinary
course
of
Only Audit committee
approval is required No approval of the
Board Audit
or
Shareholders
is
Committee
required

Take note at
the Board

Arms length transaction

means
a
transaction
between
two
related
parties that is conducted
as if they are unrelated, so

RPT is not at arm's

length basis or not in

Not exceeding the

specified limits /
Boards
Audit
Committee
approval

Exceeding the
specified limits /
Shareholders
Boards
Audit
Committee
approval
approval

Related Party Transactions

Flowchart for Related Party Transaction Approval via omnibus approval
(for Listed and unlisted Public companies)

Related Party Transactions

Important concepts for determination of Related Party Transactions
Every transaction with a related party, which is either not on arms length basis or not in the
ordinary course of business are required to be approved by the Board of Directors and
Shareholders, if exceeding the ceilings prescribed under the Act or the Listing Agreement.
Therefore, it is essential to understand the meaning of these two factors:
1. Ordinary course of business
2. Arm Lengths basis
Ordinary course of business
Ordinary course of business has not been defined in the Act. Accordingly, the meaning of the
expression ordinary course of business has to be construed in common parlance. The Black Law
Dictionary, 7th Edition, defines course of business as normal routine in managing a trade or
business. It also states that course of business is also termed as ordinary course of business,
regular course of business, ordinary course, regular course.
Institute of Chartered Accountants of India (ICAI) in its Standard on Auditing 550 on Related
Parties, specify the parameters to identify transactions which might be considered as outside
entitys ordinary course of business, such as:
a) Whether the transactions are overly complex, such as corporate restructuring or acquisitions;
b) Transaction with offshore entities in jurisdictions with weak corporate laws
c) Has unusual terms of trade, such as unusual price, interest rates, guarantees and repayment
terms;
d) Lacks an apparent logical business reason for its occurrence;
e) Transaction with circular arrangements, for example, sales with a commitment to purchase.
f) Transaction is processed in an unusual manner.
g) Transactions without consideration.
Given the above, if one were to analyse these examples, then it may be possible to infer that
some of the transaction mentioned in the above examples, could in fact be transaction
undertaken in the ordinary course of business rather than otherwise. This is because the term
in ordinary course could have different meanings for different entities or different industries or
different business situations.
In view of the above, following criteria that shall be applied to determine as to whether the
proposed transaction can be said to be in the ordinary course of business or not:
a. Whether the activity is normal or otherwise unremarkable These are activities
undertaken by the enterprise as a part of its normal business. As per Accounting Standard 5
on Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policy,

Related Party Transactions

related activities in which the enterprise engages in furtherance of, incidental to, or arising
from, would also be considered ordinary activities;
b. Frequency of the Activity The more frequent an activity the more it would be
considered to be normal or ordinary;
c. Regularity of an activity This would relate to the predictability of the activity. An activity
might not be frequent in nature but it could be predictable and that would make is ordinary;
d. Activity meeting objectives Where an activity is carried out to meet the objectives of
the business it would be considered to be normal;
e. Resources committed to the activity If there are certain resources are dedicated to a
particular activity then the activity would be considered ordinary. If the resources involved
are significant and material then it is more likely that the activity is ordinary.
Thus, the transactions which are normally and routinely entered in managing a trade or business
could be regarded as transactions entered into in the ordinary course of business.
Conclusion
Given the lack of any explicit guidance, the assessment of whether a transaction is in ordinary
course of business would necessarily involve a detailed evaluation of the specific facts of each
case, bearing in mind the surrounding business and market realities. Needless to say, this would
be a subjective exercise and would need to be analysed on a case to case basis.
To conclude:
In the ordinary course of business may mean, transactions undertaken:

In normal course, i.e. not undertaken in extra-ordinary or exceptional circumstances, or

As part of customary business practices, or

As part of long standing conduct of the Company

In the ordinary course of business may not necessarily mean:

Infrequent, or

Restricted to core business

Arm Lengths basis

Explanation (b) of Sub-section (1) of Section 188 of the Act defines the expression arms length
transaction as a transaction between two related parties that is conducted as if they were
unrelated, so that there is no conflict of interest. This is a very general definition which does not
provide any methodology, provided in the Act and Rules, for evaluating and benchmarking the
RPTs with a transaction/price with an unrelated party.
Determining whether a transaction is on arms length basis is of significant judgment. This is
because many companies may be structured to provide specific goods or services that are not

Related Party Transactions

available to independent third parties. Similarly, control over / significant influence exercised by
any entity could have pricing and non-pricing connotations, therefore, this should be factored in
also while determining whether the transaction is on arms length basis or not. The Board and
Management could resort to various documented processes for ascertaining arm length basis
transaction which include:

1. Competitive Bidding
2. Determination of fairness of pricing formulae having regard to the conditions of the
contract
3. Expert valuations
4. Transfer pricing regulations
Guidance available in transfer pricing provisions Indian and International guidance
The concept of arms length price between Associate Enterprises (AEs) is present under the IT
Act and the IT Rules. In fact, Section 92C of the IT Act prescribes six methods for determining
whether the transaction between two or more AEs is at arms length price, which are listed
down as follows:
(a)

Comparable Uncontrolled Price method

(b)

Resale Price Method

(c)

Cost Plus Method

(d)

Profit Split Method

(e)

Transactional Net Margin Method

(f)

Such other method as may be prescribed by the Board (Rule 10AB)

Further, a reference can be made to the OECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations, 2010 (OECD Guidelines), which has laid down the
principles and guidelines for determining arms length price.
In addition to the above, in 2012, the United Nations also released chapters of UN TP Manual, the
framework of which is broadly similar to the OECD TP Guidelines which are probably the most
detailed guidance available on the subject of transfer pricing.
Also, the Customs Valuation Rules, 1988 provide that in cases of imports the transaction value of
identical/similar goods, deductive value and computed value methods needs to be used. These
methods are broadly similar to the methods discussed above in the Indian Transfer Pricing
provisions though there is a fair degree of difference in the manner in which the same are
applied in practice.

Related Party Transactions

Also, an examination can be made of any past precedents (or pending litigations) for the
acceptability or otherwise, of pricing of the RPTs from various statutory authorities, to determine
if the methods adopted by the Company have been accepted by various statutory authorities.
As the provisions of the CA 2013 do not provide a specific method to determine whether a
related party transaction is at arms length or not, this determination can take colour from
definitions/provisions related to arms length price under other statutes like the IT Act, OECD TP
Guidelines, UN TP Manual, Indian Customs Act, 1962, etc. Therefore, based on the above, a
company may have flexibility in applying statutorily recognised and other well-established
principles in determining whether a transaction is at arms length. However, it is advisable for
a company to establish and formulate an internal policy which is used uniformly applied to
determine whether a related party transaction is at arms length or not.
Records & Disclosure
Disclosure in the Agenda

The agenda of the Board meeting at which the resolution is proposed to be moved shall
disclose(a) the name of the related party and nature of relationship;
(b) the nature, duration of the contract and particulars of the contract or arrangement;
(c) the material terms of the contract or arrangement including the value, if any;
(d) any advance paid or received for the contract or arrangement, if any;
(e) the manner of determining the pricing and other commercial terms, both included as part of
contract and not considered as part of the contract;
(f) 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
(g) any other information relevant or important for the Board to take a decision on the proposed
transaction.
Disclosure in the Explanatory Statement
The explanatory statement to be annexed to the notice of a general meeting convened pursuant
to section 101 shall contain the following particulars namely:(a) name of the related party;
(b) name of the director or key managerial personnel who is related, if any;
(c) nature of relationship;
(d) nature, material terms, monetary value and particulars of the contract or arrangement; and
(e) any other information relevant or important for the members to take a decision on the
proposed resolution.
Disclosures in the Board Report

Related Party Transactions

The Board Report shall contain following disclosures: in form AOC-2:
(a) Every contract or arrangement or transaction that is not at arms length basis or not in the
ordinary course of business with its salient terms and along with justification for entering
into such contract or arrangement or transactions;
(b) Every material contract or arrangement that is on arms length basis with its salient terms.
Under the Companies, the word Material, as used in (b) has neither been defined nor
explained. Therefore, to understand the term Material, reference needs to be drawn to the
following:
(i) AS-18 Related Party Disclosures requires disclosure in the financial statements for any
related party transaction that is in excess of 10% (deemed to be material) of the total
related party transactions of the same type, unless on the basis of facts and circumstances
of the case it can be concluded that even a transaction of less than 10% is material. Herein,
material has been considered for the purpose of segregating from aggregated related
party transactions of a similar type, transactions with an individual entity.
(ii) SEBI regulations specify that the transaction is material, if the transactions to be taken
individually or taken together with previous transactions during a financial year exceed 10%
of the annual consolidated turnover of the company, as per its latest audited financial
statements. This threshold is for the company as a whole instead of all related party
transactions of a similar type clubbed together, as provided in AS 18.
The definition of material related party transactions under SEBI regulations is in sync with
general corporate requirements. Therefore, the companies can voluntarily adopt the definition of
material related party transactions, as per SEBI regulations.
Registers & Records

1. Every company shall maintain one or more registers in Form MBP 4, and shall enter
therein the particulars of(a) company or companies or bodies corporate, firms or other association of individuals, in
which any director has any concern or interest, as mentioned under sub-section (1) of
section 184:
Provided that the particulars of the company or companies or bodies corporate in which
a director himself together with any other director holds two percent or less of the paidup share capital would not be required to be entered in the register;

Related Party Transactions

(b) contracts or arrangements with a body corporate or firm or other entity as mentioned
under sub-section (2) of section 184, in which any director is, directly or indirectly,
concerned or interested; and
(c) contracts or arrangements with a related party with respect to transactions to which
section 188 applies.
2. The register shall be kept at the registered office of the company and the register shall be
preserved permanently and shall be kept in the custody of the company secretary of the
company or any other person authorised by the Board for the purpose.
Penalties
Any 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 shall,
(i) in case of listed company, be punishable with imprisonment for a term which may extend
to one year or with fine which shall not be less than twenty-five thousand rupees but
which may extend to five lakh rupees, or with both; and
(ii) in case of any other company, be punishable with fine which shall not be less than twentyfive thousand rupees but which may extend to five lakh rupees.