According to international financial reporting standards, an entity is termed as related party as per following criteria:
- Highly influenced by a Key Management Personnel (KMP) or relative.
- Any firm wherein partner is director/manager or his relative
- Any public venture wherein its director or relative holds company’s 2% paid up shares.
- Director of Company or his relative in case of private company.
- Any individual whose advice company’s high officials follow.
Any kind of business deal or arrangement between such parties is termed as Related Party transaction.
Section 188 of Companies Act 2013 states all the details of sales, supply or purchase of related party transactions. It is applicable to both private as well as public sector. It also provides all related approvals as well as disclosures. It includes following important identifications for Related Party transactions:
- Any kind of sale, purchase or supply of material
- Disposing or selling of any kind of property
- Any kind of property lease
- Services availed or rendered
- Appointment of related party to any office or profits in Company
- Companies security undertakings or usage of derivatives
- Sale of goods or any agent’s appointment
Also Read: Distinction Between A Public Company And a Private Company
Above mentioned transactions can be carried on without passing shareholder’s approval if –
- Transactions are done in company’s ordinary course of business
- Arm Length transactions: When transactions are done as if parties are non-related.
For any kind of transactions Ordinary Resolution passed in the shareholder’s meeting is required. All approvals are given with the consent of Board of Directors through a resolution at Board meeting. Under 2013 act, Audit committee will give omnibus approval* for related party transactions on annual basis.
Under Section 188(2) of Companies Act 2013, every contract agreed in accordance to Section 188(1) must be mentioned in annual board report along with proper justification.
In few scenarios special approvals are also needed along with general approvals. Such Cases includes:
- Company having paid up shares of ten crores or more.
- Appointment in place of profit in the company or to any office, associate or subsidiary company at a monthly remuneration exceeding Rs. 2.5 Lakhs
- Remuneration cost for underwriting the subscription of any derivatives or securities exceeding 1% of the net worth
- If sales or purchase via self or agent exceeds 25% of annual turnover.
- Sale/purchase/supply of any goods/materials directly or indirectly through an agent, exceeding 10% of the turnover of company or Rs. 100 crore/-, whichever is lower
- Selling/disposing of/buying property of any kind, directly or indirectly or through an agent exceeding 10% of net worth of the company or Rs. 100 crore/-, whichever is lower
- Leasing any property via self or agent exceeding 10% of its turnover or Rs 100 crore/-, whichever is lower
- Availing/rendering of any services via self or agent exceeding 10% of its turnover or 50 crore/-, whichever is lower.
Net worth is calculated as per various sub clauses of section 188. Finally, a disclosure needs to be made in the resolution of Board Meeting. It includes various details like name of related parties, contracts, nature of relationship etc. Other disclosures are with directors, board reports, for registration of contracts etc.
A heavy penalty is levied for cases of noncompliance. Listed company are imposed a fine ranging Rs 25000 to Rs 500000. In some cases imprisonment is also imposed for a term of 1 year.
It’s better to know each and every details while doing any kind of transactions. Companies Act is kind of bible for Indian finance sector. There is a lot more sections and details under this act which are mandatory knowledge for all. If you want to know more or have any queries reach out to us.
*By omnibus approval we mean that audit committee may give a combined approval for all the related party transactions happening in a year.