What constitutes a related-party transaction?
Organizations often utilize shared resources and conduct transactions within the group or affiliated entities. This arrangement between two parties is referred to as a related-party transaction (RPT). Common examples of related parties include holding companies, subsidiaries, branch offices, shareholder groups, associate group entities, and key manage ment personnel.
While the concept of RPT is legitimate and regulated under various laws, these transactions are often scrutinized for potential conflicts of interest with minority shareholders and external stakeholders of an organization. For instance, a subsidiary company paying a management/royalty fee to its holding company that is not proportionate to the benefits received.
Understanding the regulations
Provisions related to related-party transactions (RPTs) are governed by Section 188 of the Companies Act, 2013, effective from 1 April 2014, and the SEBI (LODR) Regulations, 2015. These regulations outline the approval process and require disclosure of RPTs, providing stakeholders with essential information to assess the impact of such transactions.
The regulatory framework necessitates extensive disclosures of RPTs, adherence to approval mechanisms, and, most importantly, conducting RPTs at arm’s length prices. Despite the regulatory framework governing RPTs, several challenges may arise concerning governance and transparency. These challenges may stem from the unique nature of transactions or insufficient policy frameworks and documentation. Consequently, companies must reassess their approach to RPT governance, regulatory compliance, and the establishment of robust and transparent documentation.
Key legislations governing RPT
The Companies Act, 2013 (the Act) and SEBI (Listing Obligations and Disclosure requirements) regulations, primarily outline the policies and compliance requirement for RPT.
The Income-tax Act covers RPT between two domestic related parties to the extent that either of the entities is availing tax. GST and special valuation law lay down requirements for related party supply.
Regulations require RPTs to be undertaken in the ordinary course of business on an arm's length basis.
Robust RPT policies and compliance requirements instill more responsibility and accountability for the key management personnel, board members, independent directors, audit committee members.
Penal provisions in case of RPT-related non-compliance.