Related
party transactions are those where two parties who share some common benefit in
carrying out a particular transaction. This article will provide the
definition, provisions and restrictions contained in Companies Act, Income Tax
Act and Accounting Standards.
The provisions, guiding the related party
transactions are available under Section 297 of the Companies Act, 1956.
The
Companies act does not define the term “related party” instead, it mentions the
term “interest”.
The
act restricts the contracts to be entered by the company with related parties. The
company without the consent of the board cannot enter into contracts with a
Private company or a firm where any directors/ relative of a director are
interested in any way as a Director/partner/member of such private company. The
following are the transactions:
1.
For sale or purchase or supply of goods and services
2.
For underwriting or subscribing to shares or debentures of the
company.
So
the contracting party should not be a PRIVATE COMPANY or a FIRM where directors
are interested. And if the company has a paid up share capital of Rs. 1 crore
or more it should get the approval of Central Government.
If
such a transaction is at prevailing market price or if the value of such a
transaction is up to Rs. 5000 in aggregate in any year for the period comprised
in the contract, the approval of the Central Government is not required.
In
case of urgent necessity such contracts can be entered by the company without
getting the approval of the board and within 3 months of entering into
contract, the board’s approval should have been received.
For
the purpose of related party transactions, the resolution of the board must be
obtained “AT THE MEETING” and not by way of circular resolution.
Practical
Procedure:[1]
Prior
notice of the contract must be sent to the board members along with the agenda
of the meeting.
During
the board meeting, while considering the transaction, the interested director
must stay away from the proceedings for that particular resolution.
What if?
If
the consent of the board is not obtained to any contract then, anything done in
pursuance of the contract shall be void at the option of the board.
Registers to be maintained:
Register
under Section 301 - the provisions of this section mandates, the maintenance of
a register detailing the contracts entered into by the company with the related
parties. The same register must be placed at the meeting of the board.
Section
301(3) – register relating to the companies or firms in which directors are
interested. This register must be entered with the details provided by the
directors in Form 24AA as per Section 299(3).
“The intention of
these provisions is to keep a check on the directors in carrying out the
business of the company in their favor.
The act specifically restricts the transactions to be
entered with a private company, as in most private companies the directors and
members are one and the same.”
The Income tax Act disallows the expenditure
incurred in respect of Related
Parties, if in the opinion of the Assessing
officer, the expenditure is excessive and unreasonable.
These
expenditures are (a) the fair market value of goods, services or facilities for
which the payment is made or persons (Related Parties) or (b) legitimate needs
of business or profession of the assessee or (c) the benefit derived by or
accruing to the assessee from the payment.
Income
Tax act defines the following persons as a related party under section 40A
(2)(b)
(i) Where the assessee is any relative of the assessee;
individual
(ii) Where the assessee is a any director of the company, company,
firm, association partner of the firm, or member of of persons or Hindu
undivided the association or family, or any family relative of such director,
partner or member;
(iii) Any individual who has a substantial interest in the
business or profession of the assessee, or any relative of such individual;
(iv) A company, firm, association of persons or Hindu undivided
family having substantial interest in the business or profession of the
assessee or any director, partner or member of such company, firm, association
or family, or any relative of such director, partner or member;
(v) A company, firm, association of persons or Hindu undivided
family of which a director, partner or member, as the case may be, has a
substantial interest in the business or profession of the assessee; or any
director, partner or member of such company, firm, association or family or any
relative of such director, partner or member;
(vi) Any person who carries on a business or profession,
- (A) Where the assessee being an individual, or any relative of such
assessee, has a substantial interest in the business or profession of that
person; or
(B) Where the assessee being a company, firm, association of
persons or Hindu undivided family, or any director of such company, partner of
such firm or member of the association or family, or any relative of such
director, partner, or member, has a substantial interest in the business or
profession of that person.
Explanation: For the purposes of this sub-section, a person shall
be deemed to have a substantial interest in a business or profession, if
- (a) In a case where the business or profession is carried on by a
company, such person is, at any time during the previous year, the beneficial
owner of shares (not being shares entitled to a fixed rate of dividend whether
with or without a right to participate in profits) carrying not less than
twenty per cent of the voting power; and
(b) In any other case, such person is, at any time during the
previous year, beneficially entitled to not less than twenty per cent of the
profits of such business or profession. “
“So, the probability of being taxed for such a related
party transaction is in the opinion of the Assessing Officer. “
The
Accounting Standard 18 (AS 18) issued by the ICAI, has the following
provisions to be complied with respect to related party transactions. They must
be disclosed by Companies in their financial statements.
[2]Definitions of various terms:
Related party - parties are considered to be related
if at any time during the reporting period one party has the ability to control
the other party or exercise significant influence over the other party in
making financial and/or operating decisions.
Related party transaction - a transfer of resources
or obligations between related parties, regardless of whether or not a price is
charged.
Control – (a)
ownership, directly or indirectly, of more than one half of the voting power of
an enterprise, or (b) control of the composition of the board of directors in
the case of a company or of the composition of the corresponding governing body
in case of any other enterprise, or (c) a substantial interest in voting power
and the power to direct, by statute or agreement, the financial and/or
operating policies of the enterprise.
Significant
influence - participation in the financial and/or operating policy decisions of
an enterprise, but not control of those policies.
An Associate
- an enterprise in which an investing reporting party has significant influence
and which is neither a subsidiary nor a joint venture of that party.
A Joint venture - a contractual arrangement whereby
two or more parties undertake an economic activity which is subject to joint
control.
Joint control - the contractually agreed sharing of
power to govern the financial and operating policies of an economic activity so
as to obtain benefits from it.
Key management personnel - those persons who have
the authority and responsibility for planning, directing and controlling the
activities of the reporting enterprise.
Relative – in
relation to an individual, means the spouse, son, daughter, brother, sister,
father and mother who may be expected to influence, or be influenced by, that
individual in his/her dealings with the reporting enterprise.
Holding company - a company having one or more
subsidiaries.
Subsidiary - a company:
(a) in which another company (the holding company)
holds, either by itself and/or through one or more subsidiaries, more than
one-half in nominal value of its equity share capital; or
(b) of which another company (the holding company)
controls, either by itself and/or through one or more subsidiaries, the composition
of its board of directors.
Fellow subsidiary - a company is considered to be a
fellow subsidiary of another company if both are subsidiaries of the same
holding company.
State-controlled enterprise - an enterprise which is
under the control of the Central Government and/or any State Government(s).
The
standard describes the related parties as:-
1.
Enterprises that are directly or indirectly controlled by the
reporting enterprise.
2.
Associate company or Joint venture and the investing party or
venturer of the reporting enterprise.
3.
Individuals having a direct or indirect voting power in the
reporting enterprise and relatives of such individuals.
4.
Key Management Personnel and their relatives
5.
Those enterprises where the persons mentioned in (4) & (5) have
a significant influence and enterprises having common key managerial personnel.
The
related party disclosures as defined in the accounting standard are not
applicable when such disclosures would conflict with the reporting enterprise’s
duty of confidentiality.
The
term substantial interest means owning directly or indirectly 20% or more of
the voting power of the reporting enterprise.
This
standard requires that even if no transactions are carried out during a
financial year, the relationship must be disclosed in the financial statements.
Spirit of this standard:
When
there is no beneficial relation between two parties in a transaction, it is
assumed that the transactions are carried out in an Arm’s Length Price. But
when there exist any interest between the parties, the transactions might be
charged at a price which is beneficial to them. The resulting accounting measures may not
represent what they usually would be expected to represent.
“These are the various
provisions, to be complied, under various statutes with respect to related
party transactions by a Company.” The Accounting Standard includes various
parties as related to the company, while Companies Act requires the approval of
Board of Directors or Central Government in certain cases. But under the Income
Tax act, the power of taxation is with the Assessing officer, who must be
satisfied in allowing the expenses carried out for the related party
transactions.”
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