ANALYSIS OF COMPANIES ACT, 2013 – INSIGHT INTO RELATED PARTY TRANSACTIONS:
Provisions of disclosure of interest by director & approvals for related party transactions (RPT) has undergone a distinct change in the Companies Act, 2013. However, the same are yet to become applicable.
Government has decided to discontinue the old approval regime which required prior approval if the paid-up capital is Rs.1 Cr or above for all companies. While bringing the new set of RPT provisions, emphasis has been given on the self-governance, shareholders’ democracy and flexibility. Proposed provisions are in line with the International & domestic transfer pricing regulations under the Income Tax Act, 1961.
However in absence of any positive signals from the government to provide suitable exemptions to small companies & family concerns, it has posted a big big challenge before the promoters & professionals to undertake RPT compliance on implementation of Companies Act, 2013.
If the present scenario of no exemptions continues, there is a fear of backdoor entry of independent director in family concern and in some cases it would lead to impossibility of doing RPT.
The proposed Act grants only 1 exemption i.e. transaction made in the ordinary course of business on arm’s length basis. Taxation law has already posted a big challenge before the companies to justify the arm’s length basis pricing for RPT. This would add further fuel to the fire.
In light of above, it would be interesting to understand the new provisions.
Disclosure of interest by the Director (Section 184):
Director is required to disclose his interest or concern in other company, body corporate, firm or other association including shareholding if over 2%.
Director is also required to provide the list of relatives and any changes therein to the Company.
Such Disclosure to be made in the form to be specified, at the first board meeting which he attends after his appointment & subsequently at every first Board meeting of each Financial Year which he attends & any changes therein. Additionally, interested director has to disclose nature of his interest in any contract or arrangement & shall not participate in such meeting.
It is duty of director giving notice of interest to cause disclosure to be disclosed at the board meeting held immediacy after date of notice. (Draft rule 12.7(2))
Definition of related party (Section 2(76) and draft rule 1.3 of Chapter 1):
The ambit of parties covered under related party has increased substantially and the following will be covered with reference to a Company:
i. a director or his relative;
ii. a Key Managerial Personnel (KMP) or his relative;
iii. a firm, in which a director, manager or his relative is a partner;
iv. a private company in which a director or manager is a member or director;
v. a public company in which a director or manager is a director or holds along with his relatives, more than two per cent of its paid-up share capital;
vi. any 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;
vii. any person on whose advice, directions or instructions a director or manager is accustomed to act except advice given in professional capacity;
viii. any company which is a holding, subsidiary or an associate company ( holding 20% or more) of such company; or b. a subsidiary of a holding company to which it is also a subsidiary;
ix. Director or KMP of Holding/ Subsidiary/ Associate of the Company or his relatives;
x. Persons appointed at Senior Management cadre or Functional Heads of Holding/ Subsidiary/ Associate of the Company.
Transactions with Related Parties (Section 188):
a) sale, purchase or supply of any goods or materials;
b) selling or otherwise disposing of, or buying, property of any kind;
c) leasing of property of any kind;
d) Availing or rendering of any services.
e) appointment of any agent for purchase or sale of goods, materials, services or property;
f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
g) underwriting the subscription of any securities or derivatives thereof, of the company:
Non-cash property transactions with directors (Section 192):
Any transaction for acquisition of assets for consideration other than cash from its director or director of its holding, subsidiary or associate company or a person connected with him or such Director or such connected person is to acquire assets from the company needs prior approval of shareholders by passing an ordinary resolution.
Approval Process:
Board
Under new section the Government approval is dispensed with, however prior Board Approval is required for entering any transactions with related parties. Consent of the Board at a meeting is required, where the Interested Director shall not be present during the discussion.
Audit Committee
Terms of reference of Audit Committee also contain a clause of approval & modification to related party transactions already entered into by the Company.
Thus, if the Company has an Audit Committee, then terms of reference should specify its exact scope towards this function.
Shareholders
Companies having paid up capital of more than Rs.1 crore need to obtain prior approval for all Related Party Transactions in the the shareholders meeting by passing special resolution.
Any interested Related Party shareholder will not vote on such resolution.
Also, for all companies prior approval by shareholders is mandatory where the value of related party transactions during a financial year exceeds 5% of annual turnover OR 20% of net worth of the company as per the last audited balance sheet, whichever is higher. [Draft rule 12.14(ii)]
There is a possibility to execute contract in advance for certain period to get prior approval for Related Party Transactions.
Disclosure Requirements:
Notice of Board meeting should provide for name of related party, nature of relationship, nature, duration and particulars of contract, value and material terms of contract, advance paid or received for contract and any other important information to enable board to take decision.
(Draft Rule 12.13)
Explanatory statement annexed to notice of general meeting should provide for name of related party, name of director or KMP who is related, nature of relationship, nature, material terms, value and particulars of contract, any other important information to enable members to take decision. (Draft Rule 12.14)
In case of non-cash property transactions with directors, the notice of general meeting shall include the particulars of the arrangement along with the value of the assets involved which should be calculated by a registered valuer.
Board’s report shall refer to all the related party transactions along with proper justification for the same.
Register of Related Party disclosures and transactions is required to be maintained and authenticated by director (Section 189). It shall contain all the transactions where the value exceeds Rs. 5 Lacs during a financial year. Entry of non-cash transactions referred to under Section 192 will also be entered in this Register irrespective of value where said transactions where the transactions are entered into with a related party.
Filing compliance:
Special resolution passed pursuant to this section is required to be filed, together with the explanatory statement with the Registrar in Form No. 7.14.
Exempted transaction:
Transactions entered into by the company in its ordinary course of business with related parties at arm’s length basis will not fall within the purview of this section.
“Arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.
It would be difficult to prove the existence of Arm’s length price in Related Party Transactions.
Consequences of non-compliance:
a. Where any contract is entered into by a director or any other employee, without obtaining the consent of the Board or approval by a special resolution in the general meeting and if it is not ratified by the Board or, as the case may be, by the shareholders at a meeting within three months from the date on which such contract or arrangement was entered into, such contract or arrangement shall be voidable at the option of the Board and if the contract or arrangement is with a related party to any director, or is authorized by any other director, the directors concerned shall indemnify the company against any loss incurred by it.
b. It shall be open to the company to proceed against a director or any other employee who had entered into such contract or arrangement in contravention of the provisions of this section for recovery of any loss sustained by it as a result of such contract or arrangement.
c. A Contract entered into by the company without disclosure or with participation of interested director shall be voidable at the option of the company
d. In case of Non cash property transactions with directors, transaction in contravention of these provisions shall be voidable at the instance of the company unless the restitution of consideration is no longer possible and the company is indemnified for loss by some other person OR any rights are acquired bona fide for value and without notice of the contravention of these provisions by any other person.
e. Vacation of office of director for non-disclosure:
Office of director will be vacated on non-compliance of disclosure of interest & participation in meeting.
f. Vacation of office of director on conviction for Related Party Transactions
Offence:
Office of director will be vacated if he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years.
Penalty:
Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions of this section will be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.
Non-compliance of disclosure of interest & participation in meeting provisions will be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to one lakh rupees, or with both.
Notable Points:
There is no monetary exemption granted based on value of transaction.
There is no exemption to private company/ small company as the law stands today.
There is no exemption based on paid up capital.
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