Related Party Transactions: Section 188 Compliance Guide

Who Is a Related Party? (Section 2(76))

Understanding the definition of “related party” is the starting point for RPT compliance. Section 2(76) of the Companies Act, 2013 provides an exhaustive definition. At Virtual Auditor, we begin every RPT engagement by mapping the company’s related party universe.

Related Parties Under the Companies Act

• A director or his relative — “relative” is defined under Section 2(77) and includes spouse, father, mother, son, daughter, son’s wife, daughter’s husband, brother, and sister
• A key managerial personnel (KMP) or his relative — KMP includes the CEO, Managing Director, Company Secretary, Whole-time Director, and CFO (Section 2(51))
• A firm in which a director, manager, or his relative is a partner
• A private company in which a director or manager or his relative is a member or director
• A public company in which a director or manager holds along with his relatives two per cent or more of the paid-up share capital
• A body corporate whose Board of Directors, managing director, or manager is accustomed to act in accordance with the advice, directions, or instructions of a director or manager
• Any person on whose advice, directions, or instructions a director or manager is accustomed to act (excluding professional advisers)
• A holding, subsidiary, or associate company
• A subsidiary of a holding company to which the first-mentioned company is also a subsidiary (fellow subsidiary)
• An investing company or the venturer of the company (as defined in Ind AS)

Extended Definition Under SEBI LODR

For listed companies, SEBI LODR Regulation 2(1)(zb) provides a wider definition that includes any person or entity belonging to the promoter or promoter group, and any entity in which any related party has a significant influence (20% or more of voting rights or control over composition of the Board).

Types of Transactions Covered Under Section 188(1)

Section 188(1) lists the following categories of contracts or arrangements that require compliance when entered into with related parties:

1. Sale, purchase, or supply of any goods or materials — directly or through appointment of an agent
2. Selling or otherwise disposing of, or buying, property of any kind — directly or through appointment of an agent
3. Leasing of property of any kind
4. Availing or rendering of any services — directly or through appointment of an agent
5. Appointment of any related party to any office or place of profit in the company, its subsidiary, or its associate company
6. Remuneration for underwriting the subscription of any securities or derivatives of the company

Approval Framework: Board, Shareholders, and Audit Committee

Exemption: Ordinary Course of Business at Arm’s Length

Under the proviso to Section 188(1), transactions entered into in the ordinary course of business and on an arm’s length basis do not require Board or shareholder approval. However, the company must still:

• Maintain a register of contracts under Section 189
• Disclose RPTs in the Board’s Report under Section 134(3)(h) read with Rule 8(2) of the Companies (Accounts) Rules, 2014 in Form AOC-2
• For listed companies: obtain Audit Committee approval under SEBI LODR Regulation 23 regardless of the arm’s length exception

Board Approval

For transactions that are not in the ordinary course of business or not at arm’s length, prior approval of the Board by a resolution at a Board meeting is mandatory under Section 188(1). The interested director must not participate in the discussion and must not vote on such resolution.

Under Rule 15(1) of the Companies (Meetings of Board and its Powers) Rules, 2014, the following particulars must be disclosed to the Board:

• Name of the related party and nature of relationship
• Nature, duration, and particulars of the contract or arrangement
• Material terms including the value
• Any advance paid or received for the contract, if any
• Manner of determining the arm’s length price and the justification thereof
• Any other information relevant or important for the Board to take a decision

Shareholder Approval (When Thresholds Are Exceeded)

Under the second proviso to Section 188(1) read with Rule 15(3), the following transactions require prior approval of members by ordinary resolution:

Important: The related party to the transaction must not vote on the resolution, whether the member is a related party or not. For a template on drafting shareholder resolutions, see our board resolution templates guide.

Audit Committee Approval (Section 177)

Under Section 177(4)(iv), the Audit Committee is required to approve or give an omnibus approval for related party transactions. This applies to all companies that are required to constitute an Audit Committee (listed companies and prescribed classes of companies under Rule 6 of the Companies (Meetings of Board and its Powers) Rules).

The Audit Committee may grant omnibus approval for repetitive transactions, subject to the following conditions prescribed under Rule 6A:

• Maximum value of the transactions (per transaction and in aggregate) must be specified
• The extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval
• The criteria for granting omnibus approval must be clearly specified
• Omnibus approval is valid for one financial year and must be renewed annually

SEBI LODR Regulation 23: Additional Requirements for Listed Companies

Listed entities face a more stringent RPT compliance framework under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, particularly Regulation 23.

Key Requirements Under Regulation 23

Prior Audit Committee Approval (Regulation 23(2))

All related party transactions — regardless of whether they are in the ordinary course of business or at arm’s length — require prior approval of the Audit Committee. This is wider than Section 188 of the Companies Act, which exempts arm’s length transactions in the ordinary course.

Material RPT — Shareholder Approval (Regulation 23(4))

All material related party transactions require prior approval of shareholders by ordinary resolution. A transaction is “material” if it exceeds:

• Rs 1,000 crore or 10% of the annual consolidated turnover of the listed entity (as per the last audited financial statements), whichever is lower

Related parties cannot vote on the resolution approving material RPTs, whether they are a party to the transaction or not.

Disclosure Requirements

• Half-yearly disclosure: Listed entities must publish RPTs on the stock exchange every six months in the prescribed format
• Annual Report: The policy on RPTs and details of material RPTs must be disclosed in the Annual Report
• Corporate Governance Report: Details of RPTs must be included in the quarterly corporate governance report filed with the stock exchanges

RPT Policy

Under Regulation 23(1), every listed entity must formulate a policy on materiality of related party transactions and on dealing with related party transactions, including clear approval and review processes. This policy must be approved by the Board and published on the company’s website.

Arm’s Length Pricing: How to Demonstrate Compliance

The arm’s length standard is central to RPT compliance. At Virtual Auditor, we use the following methods (consistent with the Transfer Pricing regulations under Section 92CB of the Income Tax Act) to demonstrate that RPTs are at arm’s length:

Accepted Methods

1. Comparable Uncontrolled Price (CUP) Method: Comparing the price charged in the RPT with the price charged in comparable transactions between unrelated parties
2. Resale Price Method: Determining the arm’s length price by reducing the resale price by an appropriate margin
3. Cost Plus Method: Determining the arm’s length price by adding an appropriate mark-up to the cost incurred by the supplier
4. Transactional Net Margin Method (TNMM): Comparing the net profit margin of the controlled transaction with margins earned in comparable uncontrolled transactions
5. Profit Split Method: Splitting the combined profit from the transaction between the related parties based on their relative contributions

For valuation support in determining arm’s length pricing, visit our valuation services page. CA V. Viswanathan (IBBI/RV/03/2019/12333) provides independent valuation opinions that serve as evidence of arm’s length pricing.

Register of Contracts Under Section 189

Every company must maintain a register of contracts or arrangements in which the directors are interested, in Form MBP-4. This register must contain:

• Date of the contract or arrangement
• Name of the parties and the nature of the contract
• Terms and conditions of the contract
• Name of the interested director and the nature of his interest
• Date on which the contract was approved by the Board or shareholders
• Date on which the special or ordinary resolution was passed, if applicable

The register must be placed before the next Board meeting and be available for inspection by members during business hours. This is a frequently overlooked compliance requirement — we see violations in nearly 40% of companies we audit.

Disclosure in Board’s Report: Form AOC-2

Under Section 134(3)(h) read with Rule 8(2) of the Companies (Accounts) Rules, 2014, the Board’s Report must contain details of contracts or arrangements with related parties under Section 188(1) in Form AOC-2.

Form AOC-2 requires two categories of disclosure:

1. Details of contracts or arrangements not at arm’s length: Name of the related party, nature of relationship, duration of contract, salient terms, justification for entering the contract, date of approval by the Board, amount paid as advance, date on which the special resolution was passed, and amount of the transaction
2. Details of material contracts at arm’s length: Name of the related party, nature of relationship, nature and duration of the contract, salient terms, and value of the transaction

For company secretarial assistance with annual report disclosures, visit our company secretary services guide.

Penalties for Non-Compliance (Section 188(5))

The penalties for contravention of Section 188 are severe:

For the Concerned Director or Employee

• Imprisonment for a term which may extend to one year
• Fine of not less than Rs 25,000 which may extend to Rs 5,00,000
• Or both

For the Company

• Fine of not less than Rs 25,000 which may extend to Rs 5,00,000

Voidability of the Contract (Section 188(3))

Any contract or arrangement entered into in violation of Section 188 is voidable at the option of the Board or shareholders (as applicable). If the contract is with a related party to any director, or is authorised by any director, that director must indemnify the company against any loss incurred.

SEBI Penalties for Listed Companies

Under the SEBI Act, non-compliance with Regulation 23 of LODR can result in penalties under Sections 15A to 15HB, which include fines up to Rs 1 crore per day of default. SEBI can also initiate enforcement actions, issue show cause notices, and impose restrictions on the listed entity.

RPT Compliance Checklist for Private Companies

Private limited companies are not exempt from RPT compliance. While the thresholds and Audit Committee requirements may differ, the core obligations under Section 188 apply equally. Here is the checklist we use at Virtual Auditor for our private limited company clients:

1. Map the related party universe: Identify all related parties as defined under Section 2(76). Obtain annual declarations from directors under Section 184(1) and KMPs.
2. Classify each transaction: Determine whether each RPT falls within the categories listed in Section 188(1).
3. Check arm’s length status: Document the basis for determining that the transaction is at arm’s length. Maintain comparable transaction data.
4. Obtain Board approval: For transactions not in the ordinary course or not at arm’s length, obtain prior Board approval with the interested director abstaining.
5. Check threshold for shareholder approval: Apply Rule 15(3) thresholds to determine if ordinary resolution is required.
6. Update Section 189 register: Enter details in Form MBP-4.
7. Disclose in Form AOC-2: Include RPT details in the Board’s Report for the relevant financial year.
8. File Form MBP-1: Ensure every director files Form MBP-1 (disclosure of interest) at the first Board meeting of each financial year.

For comprehensive governance frameworks, see our corporate governance checklist for startups.

RPT Compliance for Group Companies

Companies within a group face particular challenges because intra-group transactions are, by definition, related party transactions. Common intra-group RPTs include:

• Management or brand usage fees charged by the holding company to subsidiaries
• Inter-corporate loans and investments under Section 186
• Shared services arrangements (IT, HR, finance functions)
• Transfer of employees between group entities
• Purchase or lease of property between group entities

Each of these transactions must be evaluated against Section 188 requirements independently. The arm’s length standard must be demonstrated for each transaction, and the fact that both parties are within the same group does not provide any exemption.

Transfer Pricing Overlap

For international transactions between related parties, the Transfer Pricing provisions under Sections 92A to 92F of the Income Tax Act, 1961 also apply. The arm’s length pricing determined for Companies Act compliance should be consistent with the Transfer Pricing documentation maintained under Rule 10D of the Income Tax Rules. At Virtual Auditor, we ensure both sets of documentation are aligned to avoid contradictory positions before the ROC and the Income Tax department.

For domestic transactions between related parties, Section 92BA (Specified Domestic Transactions) requires Transfer Pricing compliance if the aggregate value of such transactions exceeds Rs 20 crore in a financial year.

Our RPT Compliance Services at Virtual Auditor

We offer end-to-end RPT compliance services including:

1. Related party mapping — Comprehensive identification of all related parties under the Companies Act and SEBI LODR
2. Transaction review and classification — Categorisation of RPTs and determination of approval requirements
3. Arm’s length documentation — Valuation reports and comparable analysis to demonstrate arm’s length pricing. CA V. Viswanathan (IBBI/RV/03/2019/12333) provides independent valuation opinions.
4. Board and shareholder resolution drafting — Preparation of agenda notes, resolutions, and explanatory statements
5. Audit Committee presentations — Supporting listed companies with Audit Committee approval packages
6. Annual compliance — Form AOC-2 preparation, Section 189 register maintenance, and SEBI LODR disclosures

Contact us through our contact page or view our pricing for RPT compliance engagements.

Frequently Asked Questions

What is a related party transaction under Section 188?

A related party transaction under Section 188 is any contract or arrangement between a company and its related parties (directors, KMPs, their relatives, or entities in which they hold significant influence) covering sale or purchase of goods, supply of services, leasing of property, appointment to office, or remuneration. These transactions require prior Board or shareholder approval depending on prescribed thresholds.

Who is a related party under the Companies Act?

Section 2(76) defines related parties to include directors and their relatives, KMPs and their relatives, firms where directors are partners, private companies where directors are members, public companies where directors hold 2% or more paid-up capital, holding/subsidiary/associate companies, and fellow subsidiaries.

When is shareholder approval required for RPTs?

Shareholder approval by ordinary resolution is required when RPTs exceed the thresholds in Rule 15(3) — for example, sale or purchase of goods exceeding 10% of turnover or Rs 100 crore (whichever is lower), selling or buying property exceeding 10% of net worth or Rs 100 crore (whichever is lower), and appointment with monthly remuneration exceeding Rs 2,50,000.

What is the role of the Audit Committee in RPTs?

Under Section 177(4)(iv), the Audit Committee must grant prior approval for all RPTs. For listed companies under SEBI LODR Regulation 23, this extends to all RPTs including those in the ordinary course of business. The Audit Committee may also grant omnibus approvals for repetitive transactions, valid for one financial year.

What are the penalties for non-compliance with Section 188?

The concerned director or employee faces imprisonment up to one year or a fine of Rs 25,000 to Rs 5,00,000, or both. The company faces a fine of Rs 25,000 to Rs 5,00,000. The contract is voidable at the Board’s option, and the concerned director must indemnify the company for any loss.

Can RPTs be entered into at arm’s length without approval?

Under Section 188(1), transactions in the ordinary course of business and at arm’s length are exempt from Board and shareholder approval. However, disclosure in Form AOC-2 and maintenance of the Section 189 register are still required. For listed companies, Audit Committee approval under SEBI LODR Regulation 23 is mandatory regardless.

How does SEBI LODR Regulation 23 apply to listed companies?

Regulation 23 requires prior Audit Committee approval for all RPTs (including arm’s length transactions). Material RPTs exceeding Rs 1,000 crore or 10% of annual consolidated turnover (whichever is lower) require shareholder approval. Related parties cannot vote on such resolutions. Half-yearly and annual disclosures are mandatory.

Virtual Auditor — AI-Powered CA & IBBI Registered Valuer Firm
Valuer: V. VISWANATHAN, FCA, ACS, CFE, IBBI/RV/03/2019/12333
Chennai (HQ): G-131, Phase III, Spencer Plaza, Anna Salai, Chennai 600002
Bangalore: 7th Floor, Mahalakshmi Chambers, 29, MG Road, Bangalore 560001
Mumbai: Workafella, Goregaon West, Mumbai 400062
Phone: +91 99622 60333 | Email: support@virtualauditor.in
Book a Free Consultation