Related Party Transactions: Different Takes by the Companies Act, 2013 and the Indian Accounting Standards

Introduction

It is a well-known fact that most of the businesses in India are family-owned and controlled by the family members themselves. This has been the old age practice, and continues to be growing over a period of time in the modified form assimilate in the new juncture of doing business. In order to curb that, the Companies Act evolved itself in relation to Related Party Transactions (hereinafter referred to as “RPT”) and cater indirect connection in the ambit of RPT. The Companies Act, 2013 contains provisions specifically tailored to this practice of family members or relatives directly or indirectly the businesses in India.

Related party transactions are agreements or transactions between two parties who are connected by existing relationships or common control. These relationships can include not only financial ties, but also mutual interests, affiliations, or means of control. The unique characteristic of related party transactions is the potential of conflicts of interest, which could jeopardize the integrity of decision-making and financial disclosures. As a result, knowing the nature, implications, and regulatory frameworks surrounding related party transactions is critical for maintaining transparency, protecting shareholder interests, and respecting corporate governance standards. This article will further delve into the intricacies related to this type of transactions and their implications on the parties involved and will further draw comparison between the provisions of the Companies Act and Indian Accounting Standards with respect to Related Party Transactions.

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Who is a “related party”- what does the Companies Act, 2013 say

In simple terms, a “related party” is any party which is related to the company. A formal definition of the term can be drawn out by reading Section 2(76) of the Companies Act with Rule 3 of the Companies (Specification of definitions details) Rules, 2014. According to the said provisions, a related party for a company means:

1. A director or key managerial personnel, or any of their relative.
2. A firm, where a director, manager, or their relative is a partner.
3. A private company in which the relative of a director or manager or director or manager himself is a member or director.
4. A public company in which a director or manager is a director or holds more than 2% of the company’s paid-up share capital along with his relatives.
5. Any body corporate whose Board of Directors, managing director, or director usually acts according to the advice, directions, or instructions of any director or manager or any person at whose advice or instruction a director or manager usually acts. However, this is not applicable on the advice, directions, or instructions of a person who is giving such advice, direction, or instruction in his professional capacity.
6. Holding, subsidiary, or associate company of such company.
7. Another subsidiary company of the holding company to which the company concerned is also a subsidiary.
8. Venturer/investing company of the company concerned which shall make it the associate company of the body corporate.
9. Director other than independent director or key managerial personnel of the holding company or his relative.

The term “relative” in relation to a person in the above-mentioned points includes father, mother, son, son’s wife, daughter, daughter’s husband, brother, sister, members of an HUF, husband, and wife.

Not all transactions with the above-mentioned parties are considered “related party transactions”, there are certain criteria that must be fulfilled for a transaction to be considered a “related party transaction.” Provisions relating to related party transactions have been enumerated within Section 188 of the Companies Act read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014. These provisions contain certain transactions prescribing a threshold beyond which a company cannot enter into any contract or agreement with a related party without prior approval of the shareholders, however, general authorization within the threshold limit is given to the Board of Directors. Section 188 also includes penalties if the provisions contained therein are violated.

Related party transactions have different financial treatment than other commercial transactions. The term “related party” also has different definitions under different statutes, for example, “related party” as per GST, customs, Income Tax, and Indian Accounting Standards- all differ from each other. To limit the scope of this article, we will be comparing the provisions of the Companies Act, 2013 with Accounting Standard (AS) 18 and Indian Accounting Standard (Ind AS) 24.

Related party transactions- defined by Indian Accounting Standard

Accounting Standard (AS) 18

A “related party” refers to a situation where, at any point during the year, one entity possesses the capacity to exercise control over another entity or wield substantial influence over the latter’s financial and/or operational decisions.

Control, in this context, entails two scenarios:

1. Firstly, owning, directly or indirectly, more than 50% of the voting power in an enterprise.
2. Secondly, control refers to control over the composition of the Board of Directors of the company or control over composition of the governing body if the enterprise is other than a company.
3. Thirdly, control extends to having a significant stake (can also be less than 50%) in voting power and the ability to direct, by means of statute or agreement, an enterprise’s financial and/or operational strategies.

The primary objective of this standard is to establish precise requisites for the disclosure of two key aspects:

1. The existence of a related party relationship;
2. Transactions occurring between a reporting enterprise and its related parties.

Related party transactions involve the exchange of resources or obligations between related parties, irrespective of whether or not a price is attached to such exchange.

Furthermore, in accordance with AS-18, the term “Key Managerial Personnel” (KMP) includes “those persons who have the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise.”

According to Accounting Standard 18 (AS-18), the term “relative” encompasses a wide range of affiliations of the company. This includes:

1. Associate companies
2. Subsidiary companies
3. Fellow subsidiaries
4. Intermediary companies
5. Controlled companies
6. Holding company
7. Key Managerial Personnel and their relatives
8. Individuals holding direct or indirect interests in the reporting enterprise, possessing voting power within the enterprise, exercising substantial influence over the reporting enterprise, or being related to such individuals who possess such interests or voting power.

Indian Accounting Standard (Ind AS) 24

Indian Accounting Standard 24 mandates that a parent entity is required to make disclosures concerning its transactions and outstanding balances with entities like associates, joint ventures, or subsidiaries. Collectively, these entities are referred to as “Related party.” Thus, the term “related party” pertains to either an entity or an individual that has a connection with the reporting entity.

The primary objective of Ind AS 24 is to ensure that the financial statements of an entity incorporate the necessary disclosures. This is done to bring attention to the potential impact of related parties, transactions, outstanding balances, and commitments on the entity’s financial position and its profit or loss.

A related party is defined as an individual or entity that shares a relationship with the entity that is preparing its financial statements. The Indian Accounting Standard 24 refers to this entity as the ‘reporting entity.’ This relationship is established based on the following conditions:

1. An individual or a close family member of that individual is considered related to a reporting entity if that individual:
2. Holds control or joint control over the reporting entity.
3. Exercises significant influence over the reporting entity.
4. Is a member of the key management personnel of the reporting entity or its parent company.
5. An entity is deemed related to a reporting entity if any of the following conditions are met:
6. Both entities are part of the same group, implying that each parent, subsidiary, and fellow subsidiary is interconnected.
7. One entity serves as an associate or joint venture of the other entity (or an associate or joint venture of a group member to which the other entity belongs).
8. Both entities are joint ventures of a common third party.
9. One entity is a joint venture of a third entity, while the other entity is an associate of the same third entity.
10. The entity operates as a post-employment benefit plan, designed for the welfare of employees belonging to either the reporting entity or an entity linked to it. If the reporting entity itself is such a plan, the sponsoring employers are also considered related to it.
11. The entity is controlled or jointly controlled by an individual identified in (1).
12. An individual identified in (1)(a) and has significant influence over the entity or is a part of the key management personnel of the entity (or its parent).

The entity, or any member of the group of which the entity is a part, provides key management personnel services to the reporting entity or to its parent.

Conclusion

Related party transactions are a pivotal aspect of corporate governance and financial reporting. These interactions between entities and individuals connected by various ties carry significant implications for transparency, accountability, and equity. Regulatory frameworks like the Companies Act 2013 and standards such as Accounting Standard 18 and Indian Accounting Standard 24 emphasize conducting these transactions with integrity and stakeholders’ interests at heart. Mandated disclosure, approval mechanisms, and rigorous scrutiny safeguard shareholder interests, promote fairness, and prevent conflicts. Ultimately, related party transactions ensure responsible corporate behaviour, impacting reputation, value, and long-term success by putting in place a robust system of checks and balances so that parties do not abuse their positions in the company.

Author: Anindita Deb, in case of any queries please contact/write back to us at support@ipandlegalfilings.com or IP & Legal Filing

References

• AS 18 Related Party Transactions https://www.mca.gov.in/Ministry/notification/pdf/AS_18.pdf
• Ind AS 24 Related Party Transactions https://www.mca.gov.in/Ministry/pdf/Ind_AS24.pdf
• https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks/acts.html?act=NTk2MQ==#Related_Party_Transactions