RELATED PARTY TRANSACTIONS- HARMONISING AND REPORTING UNDER VARIOUS

STATUES
- By CA Niketa Agarwal
[email protected]
charged. The following are the related parties as per
The “Related Party Transactions” (RPTs) are under
AS-18:
heightened watch of various regulators and tax
authorities not just in India but globally. The potential (a) enterprises that directly, or indirectly
to misuse RPTs is a cause for concern all over the through one or more intermediaries, control,
world to both regulators as well as investors as has or are controlled by, or are under common
been evident from various scams and frauds in India control with, the reporting enterprise (this
and globally. includes holding companies, subsidiaries and
fellow subsidiaries);
A related-party transaction can also play a favourable (b) associates and joint ventures of the
role by saving transaction costs and improving the reporting enterprise and the investing party
operating efficiency of a company. In other words, all or venturer in respect of which the reporting
RPTs are not abusive. In fact, there may be several enterprise is an associate or a joint venture;
such transactions that are inevitable because they (c) individuals owning, directly or indirectly,
make commercial sense for the company; if an interest in the voting power of the
companies are prohibited from entering into such reporting enterprise that gives them control
transactions, it might work against the principle of or significant influence over the enterprise,
maximising the shareholder value. and relatives of any such (individual;
(d) key management personnel and relatives
The reporting and compliance under various different of such personnel; and
laws poses a challenge as definitions and compliance
differ under different statutes and regulations. This (e) enterprises over which any person
article examines the requirements under the described in (c) or (d) is able to exercise
different statutes which the companies needs to bear significant influence. This includes enterprises
in mind for related party transactions. owned by directors ormajor shareholders of
the reporting enterprise and enterprises that
The Corporate India’s related party can be have a member of key management in
summarised as follows: common with the reporting enterprise.

ACCOUNTING STANDARDS: However, disclosure is mandatory for the following

As per Accounting Standard 18-’Related Party categories of companies:
Disclosures’ issued by the ICAI, “Parties are i. Companies which are listed or are in process of
considered to be related if at any time during the listing
reporting period one party has the ability to control ii. Banks, financial institutions and insurance
the other party or exercise significant influence over companies
the other party in making financial and/or operating iii. Enterprises having turnover > Rs. 50 cr.
decisions” and Related Party transaction means “a iv. Enterprises having borrowings > Rs. 10 cr.
transfer of resources or obligations between related v. Holding / subsidiary company of any of the above
parties, regardless of whether or not a price is
COMPANIES ACT, 2013: (c) remuneration for underwriting the
As per Section 188 of the Companies Act, 2013: subscription of any securities or derivatives
thereof of the company exceeding one
Section 188(1) lists out the related party transactions
percent of the net worth as mentioned in
which is inclusive of transactions done within the
clause (g) of sub-section (1) of section 188.
meaning of the Old Section 297 and Section 314. In
addition, it has also included all related party
Here also the member interested in the resolution
immoveable property transactions. The section is
cannot vote on the resolution. However, no central
applicable to both Private and Public companies and
Government permission is required. The new Act has
is effective from 1st April, 2014. The Rules attached
not given any solution or remedy if all the board
to Section 188 imposes more compliances on certain
members are interested and similarly all members
classes of Companies and certain types of
are interested and there is no requisite uninterested
transactions.
quorum. In such situation there is no remedy
available with the Company except to appoint
As per Rule 15(3) of the Companies (Meetings of
independent directors or non related members as the
Board and its Powers) Rules, 2014:
case may be.
For the purposes of first proviso to sub-section (1) of
section 188, except with the prior approval of the
The most welcome part of related party is exemption
company by a special resolution-
to transactions which are made in the ordinary
(i) a company having a paid-up share capital
course of business made on arm’s length. The onus to
of ten crore rupees or more shall not enter
prove that the particular transaction is on arm’s
into a contract or arrangement with any
length basis is on the Company. The Companies (both
related party; or
private and Limited and even listed Companies) can
(ii) a company shall not enter into a
avail the benefit of these provisions. The ordinary
transaction or transactions, where the
course of business means the Company regularly
transaction or transactions to be entered
carries on business or regularly trades in such field
into—
and the expression “arm’s length transaction” means
(a) as contracts or arrangements with respect
a transaction between two related parties that is
to clauses (a) to (e) of sub-section (1) of
conducted as if they were unrelated, so that there is
section 188 exceeding twenty five percent of
no conflict of interest.
annual turnover in case of sale, purchase of
goods and material and ten per cent of net
Pursuant to the provisions of Section 134(3)(h) of the
worth in case of selling or otherwise
Act, the Company is also required to disclose the
disposing of, or buying, property of any kind
particulars of contract or arrangement with related
directly or through appointment of agents,
parties in the Board of Director’s report which was
leasing of property of any kind and availing or
not earlier. Moreover, as per rule 15(2) of Companies
rendering of any services directly or through
(Meetings of Board and its Powers) Rules, 2014, in
appointment of agents
case the Holding Company passes the special
(b) appointment to any office or place of
resolution in respect of related party transaction with
profit in the company, its subsidiary company
its wholly owned subsidiary company, then it shall be
or associate company at a monthly
sufficient compliance.
remuneration exceeding two and half lakh
rupees as mentioned in clause (f) of sub-
“Related Party” is defined as per Section 2(76) of the
section (1) of section 188; or
Companies Act, 2013. This definition is wider than the
definition of erstwhile Act. The relative of key
managerial person, persons accustomed to act on 40 A 2 (b) The persons referred to in clause (a) are the
directors, associate company etc. are new provisions following, namely:—
which is also a good step to plug the loop holes.

Definition of Relative: (i) where the any relative of the

As per Section 2(77) of the Companies Act, 2013: assessee is assessee;
‘‘Relative’’, with reference to any person, means an individual
anyone who is related to another, if—
(ii) where the any director of the
(i) they are members of a Hindu Undivided
assessee is a company, partner of the
Family;
company, firm, firm, or member of the
(ii) they are husband and wife; or
association of association or family, or
(iii) one person is related to the other in such
persons or any relative of such
manner as may be prescribed;
Hindu undivided director, partner or
Besides above, the following are considered
family member;
relative(s) including the step relationship Father,
Mother, Son Son’s wife Daughter Daughter’s husband
Brother Sister. (iii) any individual who has a substantial interest in
the business or profession of the assessee, or
The number of relatives comparing list given in the any relative of such individual;
erstwhile Act have been reduced which is also a (iv) a company, firm, association of persons or
welcome step. However, there is one practical Hindu undivided family having a substantial
problem with directors in knowing the firms or interest in the business or profession of the
companies or percentage of holding in which their assessee or any director, partner or member of
relatives are interested. such company, firm, association or family, or
any relative of such director, partner or
member [or any other company carrying on
Income Tax Act, 1961:
business or profession in which the first
Section 2 (41) "relative", in relation to an individual,
mentioned company has substantial interest];
means the husband, wife, brother or sister or any
lineal ascendant or descendant of that individual ; (v) 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
As per Section 40A (2) (a) Where the assessee incurs
interest in the business or profession of the
any expenditure, in respect of which payment has
assessee; or any director, partner or member
been made or is to be made to certain specified
of such company, firm, association or family or
persons (i.e., relatives or close associates of the
any relative of such director, partner or
assessee ), and the Assessing Officer is of the opinion
member;
that such expenditure is excessive or unreasonable
having regard to the fair market value of the goods, (vi) any person who carries on a business or
services or facilities for which the payment is made or profession,—
the legitimate needs of the business or profession of (A) where the assessee being an individual,
the assessee or the benefit derived or accruing to him or any relative of such assessee, has a
therefrom, so much of the expenditure, as is so substantial interest in the business or
considered by him to be excessive or unreasonable, profession of that person; or
shall not be allowed as a deduction.
 (B) where the assessee being a company, (d) As locating all such payments would be
firm, association of persons or Hindu difficult and time consuming, localise the
undivided family, or any director of area of enquiry as follows:
such company, partner of such firm or I. Call for all contracts or agreements
member of the association or family, or entered into by the assessee and list out
any relative of such director, partner or the contracts or agreements entered into
member, has a substantial interest in with the specified persons and segregate
the business or profession of that the items of payments made to them
person. under these agreements.
Explanation—For the purposes of this sub-section, a II. In case of payments for purchases and
person shall be deemed to have a substantial interest expenses on credit basis, scrutinize the
in a business or profession, if,— appropriate ledger accounts to identify
(a) in a case where the business or profession is the dealings with the specified persons.
carried on by a company, such person is, at any III. In case of cash purchases and expenses,
time during the previous year, the beneficial scrutinize the purchase or expense
owner of shares (not being shares entitled to a account. It may be necessary to restrict
fixed rate of dividend whether with or without the scrutiny only to such payments in
a right to participate in profits) carrying not less excess of certain monetary limits
than twenty per cent of the voting power; and depending upon the size of the concern
(b) in any other case, such person is, at any time and the volume of business of the
during the previous year, beneficially entitled assessee.
to not less than twenty per cent of the profits IV. In case of a large company, it may not be
of such business or profession. possible to verify the list of all persons
covered by this section. Therefore, as per
Form 3CD- Tax Audit: Circular No. 143, dated 20-8-1974, issued
by the Board, clarifies that tax auditor can
In tax audit report, an auditor is required to give
rely upon the list of persons covered
particulars of payments to persons specified under
under section 13(3) as given by the
section 40A(2)(b) under Clause 23 of the Form
managing trustee of a Public Trust.
3CD(Tax Audit Report). He is not required to give his
opinion on the unreasonability/excessiveness of the The information to be disclosed in clause 23 can be
payments. That is the Assessing Officer's prerogative found easily from the Related Party Disclosures under
only. AS 18 in the Notes to Accounts of Audited Financial
Statements as tax audit is normally conducted after
According to ICAI's Guidance Note, the tax auditor
statutory audit. However, the related parties as per
should apply the following procedures in respect of
AS 18 and the persons covered u/s 40A (2)(b) are not
this clause:
completely the same. It is to be noted that in Section
(a) Obtain full list of specified persons as 40A (2)(b), the words “substantial interest” have
contemplated in section 40A(2)(b). been given for determination of relationship of
(b) Obtain details of expenditure/payments made parties. Whereas in AS 18, the words “Significant
to the specified persons. Influence” is of importance which comes not only
(c) Scrutinise all items of expenditure/payments from substantial interest but also from statute or
to the specified persons. agreement and it means participation in
financial/operating policy decisions of the enterprise.
It is also to be noted that the definition of the term Clause 49 of Listing Agreement
“relative” in Income Tax Act is wider than as givenin
AS 18 as it also includes any lineal ascendant or Securities and Exchange Board of India (“SEBI”) has
descendant, i.e., even grandfather, grandmother, overhauled the existing Clause 49 of the Listing
great grandfather or grandmother, grandchildren or Agreement and replaced it with a revised Clause 49
great grandchildren and so on. (the “New Clause” or the “Clause”). The New Clause,
which will be effective from 1 October 2014, serves
the following objectives: align the provisions of
Impact of Domestic Transfer Pricing w.r.t Payment Listing Agreement with the provisions of the newly
to persons specified u/s 40A(2)(b) enacted Companies Act, 2013 and also provide
additional requirements to strengthen the corporate
Specified Domestic Transactions inter alia include
governance framework for listed companies in India.
expenditure in respect of which payment has been
However, certain requirement under the New Clause
made or to be made to a person specified u/s
goes a step further and imposes more stringent
40A(2)(b) provided the aggregate amount of all the
requirements of corporate governance to listed
specified domestic transactions exceed Rs. 5 Crore in
companies.
the financial year. Transfer Pricing regulations have
been made applicable with effect from 01.04.12
For the purpose of Clause 49 (VII), an entity shall be
wherein the Company entering into Specified
considered as related to the company if:
Domestic Transactions has to maintain certain
(i) such entity is a related party under Section 2(76) of
documents regarding nature of such transactions,
the Companies Act, 2013; or
record of uncontrolled transactions for
(ii) such entity is a related party under the applicable
comparability, determination of Arm’s Length Price,
accounting standards."
record of method used to calculate Arm’s Length
Price, etc. and has to ensure that the transactions are
The New Clause is based on the principle of ensuring
made at Arm’s Length Price. It would also be required
equitable treatment to all shareholders and
to obtain a report from Chartered Accountant in form
recognising the rights of all stakeholders in the
3CEB before the specified due date i.e., 30th
company. It provides that all material RPT requires
November.
prior approval of the shareholders through a special
Moreover, under Section 40A, the Assessing Officer resolution and the related parties are prohibited from
has been given power to disallow so much of voting such resolutions. Mandating the approval of
expenditure as appears excessive or unreasonable RPT by the majority of the shareholders who are not
having regard to fair market value, legitimate needs interested in the transactions can curb abusive RPT.
of business or benefit derived by the assessee as a As per Sebi, any transaction with a related party that
result of such expenditure. However, Finance Act exceeds 10 percent of the Consolidated Annual
2012 has inserted a proviso to sub section 2(a) which Turnover of the Companyon the basis of latest
says that no disallowance shall be made for audited financial statement would be considered
expenditure in respect of Specified Domestic "material". It may be noted that pre-amendment
Transactions if such transaction is at Arm’s Length Clause 49 had two thresholds, the higher of 5 per cent
Price. of the annual turnover or 20 per cent of the net
worth of the Company.

Audit Committee has been entrusted with the role of

preventing the abusive RPT. Currently, the Audit
Committee reviews RPT on a periodical basis. The
periodical reviews do not serve much purpose as a
transaction already carried out cannot be undone.
Hence, the New Clause provides that all RPT requires
prior approval of Audit Committee.

The New Clause also widens the definition of RPT

significantly. Even a transaction between related
parties without any charge has been included in the
definition of RPT. The clause shall be applicable to all
prospective transactions. The Clause requires that all
material RPTs have to be disclosed in the quarterly
compliance report on corporate governance.

Conclusion

The requirements of Companies Act 2013, Sebi norms

and Accounting standards with respect to related
party are not aligned to each other. Companies Act,
2013 requires disclosure at the time of entering into
contract or arrangement whereas accounting
standard requires disclosure at the time of entering
into a transaction. Clause 49 adds new class of related
parties to the definition thereof given under the Act
and includes close family members, fellow group
entities, joint ventures of same third party and
combinations thereof, which are not in accounting
standard or the Companies Act. Revised clause 49
requires shareholders’ approval for all material
related party transaction with no exception for
transactions in ordinary course of business or at
arms-length. Definition of material transactions
differs.

Thus, the related party transactions (RPT) are

widespread and are part and parcel of every business
group activity, particularly in emerging markets. RPT
between group companies can result in both positive
and negative effects for the investor. RPTs may help
achieve effective asset utilization as well as reduce
transaction cost or diversify risks.