Related Party Transactions

Comprehensive Guide on Related Party Transactions (RPTs)

Introduction

A Related Party Transaction (RPT)?refers to any arrangement, contract, or transaction between a company and an entity or individual with a special relationship to it. These transactions can involve the sale of goods, services, financing arrangements, leasing, or obligations between entities within the same corporate structure.

While RPTs are common in corporate structures, they pose risks such as conflicts of interest, unfair advantages, or misuse of corporate resources. To safeguard transparency and fairness, multiple legal frameworks regulate such transactions.

Why are Related Party Transactions Regulated?

1. Preventing Conflict of Interest

RPTs may lead to preferential treatment of insiders over other stakeholders. Regulatory oversight ensures transactions do not result in undue advantage.

2. Strengthening Regulatory Compliance

Various legal provisions, such as Companies Act, SEBI (LODR) Regulations, Income Tax Act, and Accounting Standards (AS 18/Ind AS 24), impose mandatory checks and approvals to maintain corporate integrity.

3. Protecting Minority Shareholders and Stakeholders

Minority shareholders, public investors, and creditors need protection from unfair dealings or excessive pricing in RPTs.

Key Regulatory Frameworks Governing RPTs

1. Companies Act, 2013

Defines related parties and prescribes approval and disclosure mechanisms under Sections 2(76), 2(77), 177, 184, 188, and 189.

Board and shareholder approvals are required based on the transaction's value.

2. SEBI (LODR) Regulations, 2015

Regulation 23?mandates audit committee pre-approval?and shareholder approval for material RPTs?in listed companies.

The definition of related parties extends to promoter groups and significant shareholders.

3. Income Tax Act, 1961

Section 40A(2)?prevents tax evasion by disallowing artificially inflated or deflated expenses involving related parties.

Section 92A to 92F?governs transfer pricing for international transactions with related parties.

4. Accounting Standards (AS 18 / Ind AS 24)

AS 18?(Indian GAAP) and Ind AS 24?(IFRS aligned) require detailed financial disclosures of RPTs in financial statements.

Transactions Classified as RPTs

RPTs can include, but are not limited to:

Sale, purchase, or supply of goods

Leasing of property

Availing or rendering of services

Loans and guarantees

Appointment to an office or place of profit

Underwriting of securities

Intellectual property transfers and royalty payments

Approval & Disclosure Mechanisms

1. Under the Companies Act, 2013

Board approval?is required for all RPTs.

Shareholder approval?is needed if the RPT value exceeds 10% of turnover or net worth.

2. Under SEBI (LODR) Regulations

Audit Committee pre-approval?is mandatory for all RPTs.

Shareholder approval?is required for material RPTs (threshold: ?1000 Cr or 10% of the annual consolidated turnover).

Omnibus approval?is allowed for recurring transactions.

3. Under Accounting Standards (AS 18 / Ind AS 24)

Requires disclosure in financial statements, including transaction nature, amount, and outstanding balances.

Case Studies of RPT Violations

1. Satyam Computers Scandal (2009)

Issue:?Falsification of accounts and related party transactions to siphon off company funds.

Regulatory Action:?SEBI barred Price Waterhouse from auditing listed companies for two years.

2. IL&FS Financial Crisis (2018)

Issue:?Mismanagement, undisclosed loans to related parties, and governance lapses led to a ?91,000 Cr default.

Regulatory Action:?National Financial Reporting Authority (NFRA) took action against auditors and executives.

Best Practices for Managing RPTs

Maintain a Master List of Related Parties?– Keep records of shareholders, directors, and entities under common control.

Conduct Independent Pricing Benchmarking?– Use market comparables to justify fair pricing.

Ensure Proper Approval Workflow?– Implement automated RPT approval tracking systems.

Conduct Regular Internal Audits?– Identify red flags in repeated transactions.

Enhance Independent Director Oversight?– Independent directors should question the necessity and fairness of RPTs.

Conclusion

Managing Related Party Transactions (RPTs)?is essential for maintaining corporate transparency and avoiding regulatory risks. Companies should adopt robust governance mechanisms, maintain thorough documentation, and ensure compliance with the Companies Act, SEBI (LODR) Regulations, Income Tax Act, and Accounting Standards (AS 18 / Ind AS 24).

With increased regulatory scrutiny and stakeholder expectations, a proactive approach?to handling RPTs can prevent financial misstatements, legal penalties, and reputational damage.

This article provides a comprehensive yet concise?overview of Related Party Transactions, ensuring that businesses and professionals remain compliant and well-informed.

Frequently Asked Questions (FAQs)

Q1. What is an arm’s length transaction?

An arm’s length transaction means a deal where both parties act independently without any undue influence, ensuring fair pricing.

Q2. How do companies disclose RPTs?

Companies must disclose RPTs in board reports (Form AOC-2), maintain contract registers (MBP-4), and provide financial statement notes under AS 18/Ind AS 24.

Q3. What are the penalties for non-compliance?

Companies Act:?Fines up to ?25 lakh for listed companies.

SEBI (LODR):?Trading suspension and fines up to ?1 crore.

Income Tax Act:?Disallowance of related party expenses and tax penalties.

Q4. Can an interested director vote on an RPT?

No. Under Section 184 of the Companies Act, a director interested in an RPT must abstain from voting.

Q5. What are material RPTs under SEBI regulations?

Material RPTs exceed ?1000 Cr or 10% of the annual consolidated turnover and require shareholder approval.

Q6. How does the Income Tax Act regulate RPTs?

Section 40A(2) allows tax authorities to disallow excessive payments to related parties to prevent tax evasion.