Arm’s Length Transaction: A transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest. The pricing and terms must be comparable to what would be agreed upon between independent parties in a similar transaction.
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.
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).
Section 188(1) lists the following categories of contracts or arrangements that require compliance when entered into with related parties:
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:
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:
Under the second proviso to Section 188(1) read with Rule 15(3), the following transactions require prior approval of members by ordinary resolution:
| Type of Transaction | Threshold for Shareholder Approval |
|---|---|
| Sale, purchase, supply of goods or materials | 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 |
| Leasing of property | Exceeding 10% of net worth, or 10% of turnover, or Rs 100 crore, whichever is lower |
| Availing or rendering services | Exceeding 10% of turnover, or Rs 50 crore, whichever is lower |
| Appointment to office or place of profit | Monthly remuneration exceeding Rs 2,50,000 |
| Remuneration for underwriting | Exceeding 1% of net worth |
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.
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:
Listed entities face a more stringent RPT compliance framework under SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, particularly Regulation 23.
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.
All material related party transactions require prior approval of shareholders by ordinary resolution. A transaction is “material” if it exceeds:
Related parties cannot vote on the resolution approving material RPTs, whether they are a party to the transaction or not.
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.
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:
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.
Every company must maintain a register of contracts or arrangements in which the directors are interested, in Form MBP-4. This register must contain:
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.
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:
For company secretarial assistance with annual report disclosures, visit our company secretary services guide.
The penalties for contravention of Section 188 are severe:
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.
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.
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:
For comprehensive governance frameworks, see our corporate governance checklist for startups.
Companies within a group face particular challenges because intra-group transactions are, by definition, related party transactions. Common intra-group RPTs include:
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.
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.
We offer end-to-end RPT compliance services including:
Contact us through our contact page or view our pricing for RPT compliance engagements.
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.
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.
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.
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.
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.
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.
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.
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An arm's length transaction is one conducted between two related parties as if they were unrelated, ensuring no conflict of interest. The pricing and terms must be comparable to what would be agreed upon between independent parties in a similar transaction.
Shareholder approval is required when transaction values exceed specific thresholds under Rule 15(3), such as 10% of turnover for goods or 10% of net worth for property leasing, subject to a limit of Rs 100 crore. Related parties are prohibited from voting on these resolutions.
No, ratification after the fact is no longer permitted. The Companies (Amendment) Act, 2017 removed the ratification proviso, meaning any transaction entered into without prior Board approval under Section 188 is voidable at the option of the Board, and the director must indemnify the company against loss.
SEBI LODR Regulation 23 requires prior Audit Committee approval for all RPTs, regardless of whether they are at arm's length or in the ordinary course of business. The Companies Act exempts such transactions from Board and shareholder approval under the proviso to Section 188(1).
Methods used to demonstrate arm's length pricing consistent with income tax regulations include the Comparable Uncontrolled Price (CUP) Method, Resale Price Method, Cost Plus Method, Transactional Net Margin Method (TNMM), and the Profit Split Method.