This article has been written by Ms. Neha Yadav, a fourth year student of University of Lucknow, Lucknow
ABSTRACT
This analysis delves into the intricacies of related party transactions governed by the Companies Act in India. It covers legal definitions, compliance requirements, and enforcement practices, emphasizing the pivotal role of adherence in maintaining market integrity and instilling confidence among investors. The regulatory landscape, encompassing provisions, disclosures, and penalties, is presented as a crucial framework for promoting transparency and ethical business practices in related party transactions within the Indian corporate sphere.
INTRODUCTION
It’s a common practice for companies to engage in business with their established professional and personal network, involving major shareholders, subsidiary firms, or minority-owned companies. Transactions may encompass sales, leases, loans, and more.
In India, the Companies Act includes provisions that deal with transactions involving related parties. These rules are designed to promote transparency and fairness by requiring disclosure and approval processes, ultimately protecting the interests of shareholders and avoiding conflicts of interest.
WHAT IS ‘RELATED PARTY TRANSACTION’ ?
A related party transaction, as defined under the law, refers to a contractual arrangement between two parties who share a pre-existing business relationship or mutual interests. For example, if a major shareholder agrees to renovate a company’s offices, it constitutes a related party agreement. While these transactions are legally permissible, they have the potential to introduce conflicts of interest or even legal complications.
To ensure transparency and mitigate potential issues, related party transactions must receive approval from the company’s management or board of directors, as stipulated by legal requirements. Failure to scrutinize and regulate such transactions can lead to fraudulent activities and financial detriment for all parties involved, emphasizing the importance of adherence to legal frameworks.
RELATED PARTY TRANSACTION IN INDIA
In India, regulations governing related party transactions are meticulously defined to uphold transparency and mitigate conflicts of interest. The Institute of Chartered Accountants of India (ICAI) enforces Accounting Standard 18, making it compulsory for businesses to disclose related party transactions in their financial statements. These disclosures play a critical role in ensuring accountability and transparency within corporate operations.
Under Section 188 of the Companies Act, 2013, the identification of related parties encompasses directors, their relatives, and key managerial personnel.
Additionally, the concept of related party transactions is addressed in Clause 49 of the SEBI regulations, which stipulates procedural conditions for such transactions. It defines related party transactions as involving the transfer of resources, services, or obligations and expands the regulatory scope beyond that of the Companies Act, 2013. This regulatory alignment ensures a comprehensive framework for monitoring and regulating related party transactions across different sectors.
Furthermore, Section 40 A(2) of the Income Tax Act, 1961, plays a pivotal role in governing related party transactions concerning tax implications. It prohibits expenditures with related parties if deemed unnecessary or unfair by the assessing officer, underscoring the need for prudence and fairness in financial dealings.
In essence, these regulatory provisions collectively aim to safeguard the interests of shareholders, prevent conflicts of interest, and promote ethical and transparent business practices in the realm of related party transactions in India.
RELATED TRADE TRANSACTION: COMPLIANCE AND DISCLOSURES
Achieving compliance with related party transactions necessitates a meticulous approach to navigate the intricate regulatory landscape. Primarily governed by provisions in the Companies Act and supplementary regulations, companies are obligated to adhere to stringent guidelines to ensure transparency and fairness.
Under Section 188 of the Companies Act, 2013, companies must secure board approval for related party transactions, with stringent scrutiny to prevent conflicts of interest. For transactions exceeding stipulated thresholds, shareholder approval becomes a requisite, adding an additional layer of oversight.
Crucially, compliance also extends to the disclosure requirements outlined in Accounting Standard 18 introduced by the Institute of Chartered Accountants of India (ICAI). This mandates comprehensive reporting in financial statements, elucidating the nature, terms, and conditions of related party transactions.
Moreover, companies need to align with SEBI regulations, particularly Clause 49, which imposes procedural conditions for related party transactions. This broader framework ensures a more encompassing oversight compared to the Companies Act alone, emphasizing the importance of robust internal controls and diligent adherence to regulatory stipulations.
Internal controls and policies play a pivotal role in compliance efforts, requiring companies to establish mechanisms that identify, monitor, and manage related party transactions effectively. Regular internal and external audits serve as a checkpoint, validating adherence to legal requirements and internal policies, bolstering the reliability of the compliance framework.
Additionally, it is imperative to consider tax implications in compliance efforts. Section 40 A(2) of the Income Tax Act, 1961, is particularly relevant, disallowing expenditures with related parties if deemed unnecessary or unfair by the assessing officer.
In essence, compliance with related party transactions demands a multifaceted approach, encompassing legal adherence, transparent disclosure practices, robust internal controls, and vigilance over tax implications. Such a comprehensive strategy not only ensures regulatory conformity but also fosters trust among stakeholders, contributing to the overarching goal of sound corporate governance.
Non Compliance of Related Party Transactions
Under the Companies Act, repercussions for contravention of Section 188 regarding related party transactions are substantial. The company has the authority to take legal action against a director or employee who enters into a contract in violation of Section 188, seeking recovery of any losses incurred. If the contract involves a related party of a director or is authorized by another director, the concerned directors must indemnify the company against any resulting losses. Violators may face penalties, with a maximum of twenty-five lakh rupees for listed companies and five lakh rupees for others. Section 164(g) disqualifies a person convicted of related party transaction offenses from directorship for five years.
In case of non-compliance with Sections 184(1), 184(2), 164, 177, and 189, there are penal provisions, including imprisonment, fines, or both. Section 164 further restricts eligibility for directorship based on past convictions. If a director contravenes Section 184(1) or 184(2), they may face imprisonment for up to one year or a fine of up to one lakh rupees.
Moving to the SEBI (LODR) Regulations, Regulation 98 outlines actions that can be taken by stock exchanges against listed entities violating the regulations. These actions include fines, suspension of trading, freezing of promoter/promoter group holding of designated securities, and any other measures specified by SEBI. Additionally, Sections 23, 23A, and 23E of the Securities Contracts (Regulation) Act, 1956, provide further penal provisions for non-compliance with listing agreements, conditions, or bye-laws of recognized stock exchanges.
To mitigate these risks, companies should prioritize compliance, implementing robust internal controls, conducting regular audits, and ensuring transparent disclosure practices. Proactive measures can safeguard the company from the legal, financial, and reputational consequences associated with non-compliance in related party transactions.
DISCLOSURE OF RELATED PARTY TRANSACTIONS
Disclosures for related party transactions play a crucial role in ensuring transparency and accountability within companies. Here are the key requirements for such disclosures:
(i) Board’s Report Disclosures:
– Every contract or arrangement entered into by the company should be mentioned in the Board’s report to shareholders. The report must also include justifications for engaging in such contracts or arrangements.
(ii) Register of Contracts or Arrangements:
– Companies are mandated to maintain a register (Form MBP-4) that records details of related party transactions. This register serves as an internal record, facilitating regulatory compliance.
(iii)Stock Exchange Disclosures for Listed Companies:
– Listed entities are obligated to disclose details of related party transactions on a consolidated basis in a prescribed format. This information should be provided to stock exchanges and published on the company’s website within specific timelines, typically 30 days from the date of publishing standalone and consolidated financial results for the half-year period.
(iv)Annual Report Disclosures for Listed Companies:
– Listed companies are required to include disclosures for related party transactions in the annual report, particularly in the corporate governance section. This ensures that stakeholders, including shareholders and investors, have access to comprehensive information regarding related party transactions.
These disclosure mechanisms serve to enhance transparency and enable stakeholders to make informed decisions about a company’s financial dealings with related parties. The adherence to these disclosure requirements is vital for maintaining trust, both within the organization and among external stakeholders.
CONCLUSION
In conclusion, the analysis of related party transactions and their regulatory framework under the Companies Act in India reveals a comprehensive and stringent system designed to promote transparency, fairness, and ethical conduct in corporate dealings. The provisions outlined in the Companies Act, including those enforced by the Institute of Chartered Accountants of India (ICAI) and the Securities and Exchange Board of India (SEBI), collectively aim to safeguard the interests of shareholders, prevent conflicts of interest, and foster a culture of ethical and transparent business practices.
The emphasis on compliance with related party transactions involves obtaining necessary approvals, meticulous adherence to disclosure requirements, and alignment with SEBI regulations. The penalties and disqualifications for non-compliance underscore the seriousness with which regulatory bodies approach these matters, emphasizing the need for companies to establish robust internal controls, conduct regular audits, and ensure transparent disclosure practices.
Moreover, the insightful overview of the regulatory landscape provided in this analysis serves as a valuable resource for stakeholders, including students, practitioners, and businesses, seeking a deeper understanding of the legal intricacies surrounding related party transactions in India. By navigating these complex regulations with diligence and adherence, companies can contribute to maintaining market integrity, fostering investor confidence, and upholding the principles of sound corporate governance.
REFERENCES
Company Law, Avtar Singh, 9789388206518, 17th Edition
This data was originally written by an anonymous writer and published on the website Ministry of Corporate Affairs. The link for the same is herein.
This article was originally written by an anonymous writer and published on the website Groww. The link for the same is herein.
https://groww.in/blog/all-about-related-party-transactions
This article was originally written by Will Kenton and published on the website Investopedia. The link for the same is herein.
https://www.investopedia.com/terms/r/related-partytransaction.asp
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