Insights

Facts
In the current case, the holding company is availing various kinds of services from the subsidiary company, wherein the holding company is a major customer of the subsidiary company in most of the cases. The two main directors in the holding company are the director in the subsidiary company.
The question here is whether the transactions between the holding company and the subsidiary company will amount to a related party transaction.

From the Perspective of Ind AS 24 (Related Party Disclosures)
Definition of Related Party
Under Ind AS 24, Related Parties include entities within a parent-subsidiary relationship, meaning that both the holding company and its subsidiary are related parties. A related party transaction, according to Ind AS 24, refers to the transfer of resources, services, or obligations between related parties, even if no price is charged. Therefore, if a subsidiary provides services  to its holding company, this would be classified as a related party transaction.

• Required Disclosures
  Ind AS 24 mandates detailed disclosures in the financial statements, including:
  1. Nature of the relationship: Disclosure of the parent-subsidiary relationship
  2. Transaction details: Information about the type of services rendered and the amount involved.
  3. Terms of the transaction: Clarification of whether the transaction was conducted on an arm’s length basis(i.e., terms that would apply between unrelated parties)
  4. Outstanding balances: Disclosures of any year-end balances (e.g., payables or receivables)
  5. Future commitments: Any commitments to perform or receive services in the future.

• Arm’s Length Transactions and Materiality
  If the transaction is conducted at arm’s length (i.e., on terms that would be agreed upon with unrelated parties), it may be treated differently in terms of disclosure requirements. The materiality of the transaction (its significance to the company’s financial position) also plays a crucial role in determining the extent of the disclosures.
  Under Section 188 of Companies Act 2013, it emphasis on the approval of board of directors Approval is required for transactions which are not in the ordinary course of business and not at arm’s length. Whereas when the transactions meet certain threshold that is (10% of the company’s turnover or ₹50 crore, whichever is lower), shareholder approval via an ordinary resolution is required. Related parties involved in the transaction cannot vote on the resolution.
  However, if the transactions come under ordinary course of business and at an arm’s length, no such further approval .
  Even when it comes to Listing Regulations Requirements

An arm’s length transaction is one where both parties act independently, without any relationship affecting the terms. Typically, unrelated party transactions are assumed to be at arm’s length. However, companies are still required to disclose such transactions if they impact the financial position or performance significantly, even if they were conducted under fair market conditions. Arm’s length transactions are subject to fewer detailed disclosures than related party transactions but must still be reported to maintain transparency, especially if they influence the company’s financial position.

Without related party disclosures, there is a general presumption that transactions reflected in financial statements are consummated on an arm’s length basis between independent parties. However, that presumption may not be valid when related party relationships exist because related parties may enter into transactions which unrelated parties would not enter into. Also, transactions between related parties may not be affected at the same terms and conditions as between unrelated parties. Sometimes, no price is charged in related party transactions, for example, free provision of management services and the extension of free credit on a debt. In view of the aforesaid, the resulting accounting measures may not represent what they usually would be expected to represent. Thus, a related party relationship could have an effect on the financial position and operating results of the reporting enterprise.

From the Perspective of the Companies Act, 2013

Definition of Related Party and Related Party Transactions (RPT)

Under Section 2(76) of the Companies Act, 2013, related parties include the holding and subsidiary companies, making them subject to the related party provisions. Related party transactions under Section 188 include the availing or rendering of services between related parties, thus covering the services provided by the subsidiary to its holding company.

Approval Mechanism for Related Party Transactions (Section 188)
The Companies Act, 2013 requires that all related party transactions go through a proper approval process:

• Board Approval
  Any RPT must first be approved by the Board of Directors. Directors who are interested in the transaction cannot vote on the resolution.

• Shareholder Approval
  If the transaction exceeds certain thresholds (10% of the company’s turnover or ₹50 crore, whichever is lower), shareholder approval via an ordinary resolution is required. Related parties involved in the transaction cannot vote on the resolution.

• Exemptions
  Transactions between a wholly owned subsidiary and its holding company do not require shareholder approval if they are conducted in the ordinary course of business and on an arm’s length basis.

• Disclosure Requirements
  As per the Companies Act, companies must:
  1. Include details of related party transactions in the Board’s Report (Section 134).
  2. Maintain a register of all related party contracts in Form MBP-4
  3. Disclose these transactions in the company’s financial statements as per Schedule III of the Act.

• Penalties for Non-Compliance
  Failure to comply with Section 188 may result in penalties, including fines for the company and its officers. The transaction may also be rendered voidable at the discretion of the Board if not approved properly.
  Under both Ind AS 24 and the Companies Act, 2013, a transaction involving a subsidiary providing services to its holding company is a related party transaction. While Ind AS 24 focuses on disclosures to ensure transparency for stakeholders, the Companies Act, 2013 adds another layer of regulatory oversight, requiring board or shareholder approval for such transactions, depending on their size and nature.In Ind AS 24 requires disclosure of related party relationships, transactions and outstanding balances, including commitments, in the consolidated and separate financial statements of a parent or investors with joint control of, or significant influence over, an investee presented in accordance with Ind AS 110,Consolidated Financial Statements, or Ind AS 27, Separate Financial Statements. This Standard also applies to individual financial statements.

Under Section 188 (5) the penalty is given as 
5) Any director or any other employee of a company, who had entered into or authorised the contract or arrangement in violation of the provisions of this section shall,—
(i) in case of listed company , be liable to a penalty of twenty-five lakh rupees ; and
(ii) in case of any other company, be liable to a penalty of five lakh rupees 

Approval of Board and Shareholders: 

• Approval of the Board at the meeting shall be obtained through voting only by disinterested parties for all the transactions covered under Section 188 of the Companies Act, 2013. 
• Prior approval of the shareholders through resolution shall be required if the threshold limit as per the rule 15 of the Companies (Meeting of Board and its Powers) Rules, 2014 is triggered for the transaction.

Rule 15. Contract or arrangement with a related party.-
A company shall enter into any contract or arrangement with a related party subject to the following conditions, namely:-

(1) The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose-
– The name of the related party and nature of relationship;
– The nature, duration of the contract and particulars of the contract or arrangement; 
– The material terms of the contract or arrangement including the value, if any;
– Any advance paid or received for the contract or arrangement, if any;
– The manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
– Whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
– Any other information relevant or important for the Board to take a decision on the proposed transaction.

(2) Where any director is interested in any contract or arrangement with a related party, such director shall not be present at the meeting during discussions on the subject matter of the resolution relating to such contract or arrangement-

(3) For the purposes of first proviso to sub-section (1) of section 188, except with the prior approval of the company by a special resolution resolution, a company shall not enter into a transaction or transactions, where the transaction or transactions to be entered into,—
(a) as contracts or arrangements with respect to clauses (a) to (e) of sub-section (1) of section 188, with criteria as mentioned below –

(i) sale, purchase or supply of any goods or materials, directly or through appointment of agent, exceeding ten per cent. amounting to ten per cent. or more of the turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (a) and clause (e) respectively of sub-section (1) of section 188;
(ii) selling or otherwise disposing of or buying property of any kind, directly or through appointment of agent, exceeding ten per cent. amounting to ten per cent. or more of net worth of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (b) and clause (e) respectively of sub-section (1) of section 188;
(iii) leasing of property of any kind amounting to ten per cent or more of the turnover of the company exceeding ten per cent. amounting to ten per cent. or more of the net worth of the company or ten per cent. of  ten per cent. or more of turnover of the company or rupees one hundred crore, whichever is lower, as mentioned in clause (c) of sub-section (1) of section 188;
(iv) availing or rendering of any services, directly or through appointment of agent, exceeding ten per cent. amounting to ten per cent. or more of the turnover of the company or rupees fifty crore, whichever is lower, as mentioned in clause (d) and clause (e) respectively of sub-section (1) of section 188:

Shareholder approval for related party transactions is governed under Section 188 of the Companies Act, 2013. The Act outlines several compliance requirements and thresholds for obtaining shareholder approval based on the nature and value of the transactions.

1. Transactions Requiring Shareholder Approval:

• Sale, purchase, or supply of goods or materials (either directly or through agents).
• Selling, buying, or leasing property of any kind.
• Availing or rendering services (directly or through agents).
• Appointment of an agent for the purchase or sale of goods, materials, services, or property.
• Appointment to any office or place of profit in the company, subsidiary, or associate company.
• Underwriting of securities or derivatives of the company .

2. Threshold for Shareholder Approval:

• Shareholder approval by way of Ordinary Resolution is required if:
• The value of the transaction exceeds 10% of the company’s turnover or net worth, based on the last audited financial statements.
• For certain transactions, like the appointment to any office or place of profit, shareholder approval is required if the monthly remuneration exceeds 2.5 lakh rupees .

3. Exemptions:

• Shareholder approval is not necessary for transactions between a holding company and its wholly-owned subsidiary, provided the subsidiary’s accounts are consolidated with the holding company’s and presented before the shareholders at the general meeting .

Rule 15 of the Companies (Meeting of Board and its Powers) Rules, 2014 specifies the conditions under which a company must obtain shareholder approval for related party transactions.

• Transactions covered: Sale, purchase, or supply of goods; selling or leasing property; availing services, etc.
• Approval: Shareholder approval is mandatory if the transaction exceeds certain thresholds (e.g., 10% of turnover or net worth).
• Exceptions: Transactions between holding and wholly-owned subsidiaries, if consolidated, are exempt from approval.
• Rule 15 provides further details and thresholds for when shareholder approval is required for related party transactions covered under Section 188. It specifies the monetary limits beyond which the approval of shareholders is mandatory.

The thresholds include:

• Sale, purchase, or supply of goods/materials directly or through an agent: if the transaction(s) amounting 10% or more of the company’s turnover , whichever is lower.
• Selling or disposing of property of any kind directly or through an agent: if the transaction(s) amounting 10% or more of the company’s turnover, whichever is lower.
• Leasing of property: if the transaction(s) amounting 10% or more of the company’s turnover, whichever is lower.
• Availing or rendering of services: if the transaction(s) amounting 10% or more of the company’s turnover, whichever is lower.