Related Party Transaction

Introduction to Related Party Transaction

RELATED PARTIES AND BUSINESS SERVICES CAN TAKE MANY DIFFERENT FORMS. SOME
OF THE MOST COMMON TYPES OF RELATED PARTIES INCLUDE BUSINESS AFFILIATES,
SHAREHOLDER GROUPS, SUBSIDIARIES, AND MINORITY-OWNED COMPANIES.
RELATED PARTY TRANSACTIONS CAN INCLUDE SALES, LEASES, SERVICE AGREEMENTS,
AND LOAN AGREEMENTS.
IN LARGE CORPORATE SITUATIONS, PUBLIC COMPANIES ARE OFTEN MINORITY OR
MAJORITY-OWNED BY OTHER ENTITIES. THESE ENTITIES MAY HAVE SIMILAR BUSINESS
INTERESTS DUE TO BUSINESS COMMONALITIES. IN THESE CASES, RELATED-PARTY
TRANSACTIONS MAY NATURALLY OCCUR, SUCH AS VENDOR OR SUPPLIER
RELATIONSHIPS FOR THE MUTUAL BENEFIT OF BOTH COMPANIES.
A RELATED-PARTY TRANSACTION IS A BUSINESS DEAL OR ARRANGEMENT BETWEEN
TWO PARTIES WHO ARE JOINED BY A PRE-EXISTING SPECIAL RELATIONSHIP. FOR
EXAMPLE, A BUSINESS TRANSACTION BETWEEN A MAJOR SHAREHOLDER AND A
CORPORATION, SUCH AS A CONTRACT FOR THE SHAREHOLDER'S COMPANY TO
PERFORM RENOVATIONS TO THE CORPORATION'S OFFICES, WOULD BE DEEMED A
RELATED-PARTY TRANSACTION.
Importance of Related Party Transactions
While the existence of related parties and transactions between such parties are
considered ordinary features of business, the auditor needs to be aware of them
because:
 The financial reporting framework may require disclosure in the financial statements
of certain related party relationships and transactions, such as those required by IAS
24;
 The existence of related parties or related party transactions may affect the financial
statements. For example, the entity’s tax liability and expense may be affected by
the tax laws in various jurisdictions which require special consideration when related
parties exist;
 The source of audit evidence affects the auditor’s assessment of its reliability. A
greater degree of reliance may be placed on audit evidence that is obtained from
or created by unrelated third parties; and
 A related party transaction may be motivated by other than ordinary business
considerations, for example, profit sharing or even fraud.
 Several financial scandals involving related parties frequently appear in the
headlines. A true and fair view of the entity's affairs may not be given unless full
disclosure is made.
Consequences of Non-Compliance:
 Agreements voidable: Where any contract or arrangement is
entered into by a director or any other employee, without the
consent of the Board or approval by a special resolution in the
general meeting and if it is not ratified by the Board or by the
shareholders within three months from the date on which such
contract is made, then such contract or arrangement shall be
voidable at the option of the Board.
 Indemnification: If such a contract or arrangement is with a related
party to any director, or is authorised by any other director, the
directors concerned shall indemnify the company against any loss
incurred by it.
 The company can also proceed against such director or any other
employee who had entered into such contract or arrangement in
contravention of the provisions of this section for recovery of any loss
sustained by it as a result of such contract or arrangement.
SEBI govern related parties and
related party transactions
The SEBI Clause 49 states certain regulatory requirements for related
party transactions. It defines related party transaction as a
transaction which includes 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,
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.
Nature of Approval Required
A contrasting change has been introduced by the Act of 2013, in
comparison to the act of 1956 is that in the later act the previous
approval of the central government was mandatory for companies
having paid up share capital of not less than one crore rupees for
entering into any transaction with the related parties.
As per the new act of 2013 every company irrespective of its capital
needs to seek the approval of BOARD OF DIRECTORS before entering
into any related party transactions. It is necessary that such a resolution
is obtained at a meeting conducted by the board of directors. As per
rule 15 of Companies (meeting of board and its powers) Rules 2014, a
director who has `an interest` in the contract or arrangement with such
related party must not be present at the meeting during the discussions
pertaining to the subject matter of the contract or arrangement.
Nature of Approval Required
(continued…)
In following cases, in addition to the approval of board of directors, prior approval of members by
special resolution must be sought before entering into related party transaction
All related party transaction in case of companies having paid up share capital of Rupees 10 crores or
more-
 Sale, purchase or supply of any goods or materials directly or through appointment of agents
exceeding 25% of annual turnover
 Selling or disposing of property of any kind directly or through appointment of agents exceeding 10%
of the net worth
 Leasing property of any kind exceeding 10% of the net worth
 Availing or rendering services directly or through appointment of agents exceeding 10% of the net
worth
 Remuneration for underwriting the subscription of any securities or derivatives thereof of company
exceeding 1% of the net worth
 In case of a Special Resolution in an extraordinary general meeting, no member of the company
who is a related party shall cast a vote on such a special resolutions which aim at approving any
contract or arrangement which may be entered into by the company. In case of wholly owned
subsidiary the special resolution passed by the holding company shall be considered sufficient for
entering into transactions between wholly owned subsidiary and the holding company.
Disclosure Norms
Board Meeting
The agenda at the board meeting in which a resolution is to be passed must
consist of the following:
 Name and nature of the relationship with the related party
 The duration of the contact
 Material terms of the contract or arrangement
 If any advance has been paid or received for the contract or
arrangement
 Manner of determining pricing and commercial terms both of which form
a part of the contract and the once that are not considered part of the
contract.
 Any other relevant or important transaction undertaken by the board.
Disclosure Norms (continued…)
Disclosure by interested directors
 Every director of a company who has any direct or indirect interest
involved in the contract or arrangement entered into or about to be
entered in to must disclose the nature of his concern or interest at
the meeting of the board in which such contract or arrangement is
discussed.
Board Disclosures
 Every related party transaction or a contract or an arrangement
shall be disclosed in the board`s report along with the justification for
entering into such contract or arrangement
Disclosures to be made in the Register
 Every country has to maintain one or more registers in MBP 4, and
shall enter the particulars of the contract or arrangement with a