A related party transaction is a two-party contract which is accompanied by a pre-existing business relationship or mutual interest.
For example, it would be a related party agreement to have a contract between a major shareholder of a company and the company if such shareholder agrees to renovate the offices of the company.
Companies also aim to establish business relationships with parties they are familiar with or have common interests. While these kinds of transactions are legal, they may pose a conflict of interest or lead to another illegal situation.
Therefore, related party transactions have to be approved by agreement of management or board of directors of the company. If unchecked, the misuse of related party transactions could result in fraud and financial ruin for all parties involved.
Who is a Related Party?
Following are the related parties with respect to Company LMN Ltd (LMN Ltd is taken as an example for explaining purposes). Let’s say, Mr L, M, and N are directors in this company. The related parties for the company, in general, are as under:
| Sl no | Related Parties | Examples |
| 1. | A director or his relative (Relative means a member of the same HUF, husband, wife, father, stepfather, mother, stepmother, son, stepson, son’s wife, daughter, daughter’s husband, brother, stepbrother, sister, step-sister) | Mr L, Mr M and Mr N are directors and the relatives of these Directors are considered as related parties. |
| 2. | Key managerial personnel or his relative | Say, Mr O is a Company secretary, his relatives will be considered related parties |
| 3. | A firm in which a director, manager, or relative is a partner | Mr L is a partner at RST. Pvt. Ltd, another firm. This firm will also be considered as a related party. |
| 4. | A private company in which a director, manager, or relative is a member or director | Mr. M is a director in M Pvt Ltd – In this case M Pvt. ltd becomes a related party. Even when Mr. M’s relative is a member or director in M Pvt ltd, this company will be considered as a related party. |
| 5. | A public company in which a director or manager is a director and holds along with his relatives more than 2% of its paid-up capital | Mr. N along with his relatives holds more than 2% of the paid-up capital of N ltd. In this case, N Ltd will be considered as a related party. |
| 6. | Any body corporate whose board of directors, MD or manager is required to act in accordance with the advice, directions or instructions of a director or manager (NA in cases when these directions are followed in a professional capacity) | When P Ltd acts on the directions of Mr. L, P Ltd will be a related party. |
| 7. | Any person on whose advice, directions or instructions a director or manager is required to act (NA when this is done in a professional capacity) | Mr A holding 51% in LMN Ltd on whose advice Mr L has to act will be considered as a related party. |
| 8. | Holding, Subsidiary or Associate of such company | These all will be considered as related parties: – ABC Ltd holding 51% in LMN Ltd (Holding Company) – LMN Ltd holding 51% in XYZ Ltd (Subsidiary Company) – DEF Ltd holding 30% in LMN Ltd (Associate Company) |
| 9. | Any company which is a subsidiary of a holding company to which it is also a subsidiary | PQR & LMN are both subsidiaries of ABC ltd. Thus, PQR also becomes a related party |
Meaning of Related Party Transactions
Since we are acquainted with the term related party let us dive into the transactions covered. The broad categories are mentioned hereby:
| Sl no | Transactions as per Companies Act requiring approval of the Board by resolution | Transactions as per The Companies (Meetings of Board and its Powers) Rules 2014 requiring approval by the company by resolution |
| 1. | Goods and Material: Sale, purchase or supply | Sale/Purchase/Supply of goods/material directly or through an agent covering 10% or more of turnover OR one hundred Crores (whichever is lower). |
| 2. | Property: Selling or buying or leasing | Sale/Purchase of property directly or through an agent that is 10% or more of net worth OR one hundred Crores (whichever is lower). In case of leasing of property directly covering 10% or more of turnover OR one hundred Crores (whichever is lower). |
| 3. | Agent for (1) and (2) above | Availing or rendering of services directly or through an agent which is 10% or more of turnover OR fifty Crores (whichever is lower). |
(All the above limits are to be taken on all transactions done on a financial year basis.)
| Sl no | Transactions as per Companies Act requiring approval of the Board by resolution | Transactions as per The Companies (Meetings of Board and its Powers) Rules 2014 requiring approval by the company by resolution |
| 4. | Others: – Availing of or the rendering of services – Underwriting of securities or derivatives – Related partys’ appointment to a place of profit or office* in the company/subsidiary/associate – If the Director or individual other than director/firm/private company/body corporate receive from the company an amount over and above the remuneration (In the case of directors) and anything by way of remuneration for others will need the approval of the Board by a resolution. | – Related party’s appointment to the place of profit or office* in the company/subsidiary/associate where the remuneration exceeds two and a half lakh. – Underwriting of securities or derivatives when remuneration exceeds 1% of the net worth. |
Related Party Transactions in India
In India, various regulations clearly outline the definition of a related party transaction. It helps to ensure that they are conflict-free. In the case of a company, it helps to ensure that it does not negatively affect the shareholders’ value or its profits.
The Institute of Chartered Accountants of India (ICAI) introduced Accounting Standard 18- ‘Related Party Disclosures’ and made it mandatory for businesses to report related party transactions in the financial statements. Apart from this, various laws refer to these transactions.
SEBI Governs Related Parties and Related Party Transactions
The SEBI Clause 49 also states certain regulatory requirements for related party transactions. It defines a related party transaction as a transaction that includes the transfer of resources/services/obligation.
Its scope is of a wider range than the Companies Act 2013. It includes close family members of directors or key managerial personnel, a private company in which directors or key managerial personnel plus their relatives have control or significant influence.
Every related party transaction which is material has to be approved by the shareholders by passing a special resolution and all related parties shall not be allowed to vote on such resolutions.
Section 188 of the Companies Act, 2013
Related parties can be the key managerial personnel of the company, such as the manager, CEO, CFO, CTO, or managing director.It extends to the firm or private company in which this director or the manager is a partner or shareholder or director. If such company is a public company, then it will be termed as a related party if the director/relative holds more than 2% of its paid-up capital.
Holding, subsidiary, or associate companies are also covered. Companies with common management/ownership are also related. Any sale, purchase, lease, rent, or hiring, taking place between the M/s PQR company and the above parties shall be termed as a related party transaction.
Clause 49 of the SEBI also provides for some procedural conditions for related party transactions. It describes a related party transaction as a transaction involving resource/service/obligation transfer. The scope is higher than that of the Companies Act, 2013.
Section 40 A (2) in the Income Tax Act, 1961
A notification that a related party transaction took place during the year serves no function unless one is aware of the terms of the transaction and the tax consequences.
Section 40 A(2) of the Income Tax Act disallows the expenditure incurred with related parties if the assessing officer finds that the expenditure is unnecessary and unfair.
FAQs
What is a Related Party Transaction (RPT)?
A Related Party Transaction occurs when two parties have a pre-existing relationship or connection before entering into a business deal. These relationships could include family ties, ownership interests, or other close affiliations.
Why are Related Party Transactions Significant?
RPTs can raise concerns about fairness, transparency, and potential conflicts of interest. Recognizing and disclosing these transactions is crucial for maintaining corporate governance and ensuring fair treatment of all stakeholders.
Who Qualifies as a Related Party?
Related parties include individuals or entities with a close relationship to the company. This can involve key management personnel, major shareholders, immediate family members of key executives, and other entities where there is the potential for influence or control.
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