Related Party Transactions For Private Limited Company

In corporate world, it is a common practice for promoters and directors to have multiple business entities at the same time. Commercially, they operate and enter different transactions through their associates, subsidiaries or joint ventures. These transactions are legal, but they carry an inherent risk where the management or controlling shareholders may misuse it to their benefit.

This risk is of significant nature and to address the same, Section 188 of the Companies Act, 2013 was enacted to regulate all contracts and arrangements between a company and its Related Parties.

Related Party Transactions requires transparency and proper record keeping that transactions are entered at arm length basis. The role of management is crucial to exercise due diligence before approving any related party transaction and act in good faith with due and reasonable care. The management shall satisfy themselves that the proposed transaction is not detrimental to minority shareholders and in the best interest of the company.

In this blog, we shall walk you through the rules and compliance of Related Party Transactions for Private Limited Company that must be complied with for smooth functioning of the business.

Table of Contents

Who is Related Party as per Companies Act, 2013?

Section 2(76) of the Companies Act, 2013 defines the term related Party which basically covers people and entities that have a close connection with the company. In simple words, related party includes: –

A director of the company or his/her relative,
A key managerial personnel like MD, CEO, CFO, Company Secretary or his/her relative,
A firm where a director, manager, or their relative is a partner,
A private company where a director/manager or their relative is a member or director,
A public company where a director/manager (along with relatives) holds more than 2% of its paid-up share capital,
Any body corporate whose Board, MD, or manager usually acts as per the directions or instructions of the company’s director or manager (except purely professional advice),
Any person or entity on whose advice a director or manager of the company normally acts (again, excluding professional capacity),
And importantly, holding company, subsidiary company, associate company, or another subsidiary of the same holding company.

Further, the Companies Act, 2013 defines relatives in section 2(77) of the Companies Act, 2013 including spouse, parents, children, siblings, and their spouses to create a quite wider scope to prevent the oppression of minority shareholders.

Related Party Transactions for Private Limited Company such as contracts, leases, loans, or any material dealings requires special approvals, disclosures, and in certain cases shareholders’ approval are required under Section 188 of the Companies Act, 2013.

What constitutes Related Party Transactions for Private Limited Company?

In India, Related Party Transactions for Private Limited Company (commonly referred as RPTs) are the specific contracts or deals executed by the company with individuals or entities closely connected to it, as defined under the Companies Act, 2013.Section 188 of the Companies Act, 2013 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 covers the rules and compliance of Related Party Transactions for Private Limited Company.

The objective behind these rules and compliances is to avoid conflicts of interest, ensure fairness through arm’s length pricing, and protect the company and its shareholders from deals that might benefit insiders in an unfair manner.

The transactions that are covered under Section 188 of the Companies Act, 2013 are: –

Purchasing, selling, or supplying goods or materials: This refers to any exchange of goods or materials between the business and a connected party, including inventories, supplies, finished goods, and raw materials.

Purchasing, selling, or otherwise disposing of property: This refers to the transfer or acquisition of any type of property, whether it be immovable like land or buildings or moveable like machinery, cars, or equipment.

Leasing any type of property: This refers to renting out or accepting rent for assets such as vehicles, equipment, office space, factory sheds, or other assets.

Giving or receiving services: This refers to circumstances in which the business provides services, such as consultancy, IT support, logistics, management assistance, or any other professional or technical support, to a connected party or receives services from them.

Using a related party as an agent, broker, or intermediary to manage purchases, sales, or transactions involving products, materials, services, or property: This is covered if the business uses a related party as an agent, broker, or intermediary.

Assigning a related person to an office or place of profit: This occurs when a related party is given a paid role or position in the business, its affiliate, or subsidiary.

Underwriting the company’s derivatives or securities: It also counts if a linked party consents to underwrite, or guarantee, the subscription of the company’s debentures, shares, or other securities.

These specific seven categories constitute Related Party Transactions for Private Limited Company. For private Limited companies, there are certain exemptions as well: –

No shareholder approval is required, and board resolution suffice if the transaction is in the ordinary course of business AND on an arm’s length basis.
Shareholder special resolution is exempted for private limited companies via MCA notifications.

Approval Requirements for Related Party Transactions

The Companies Act, 2013 mandates certainapproval requirements for Related Party Transactions to ensure fairness and transparency and prevent misuse of insider positions.

The Approval Process is listed as follows: –

Step 1: – Pass Board resolution at board meeting. No circular resolutions are allowed.

Step 2: – As per Section 184 of Companies Act, 2013, interested directors must disclose their interest in form MBP-1 and shall abstain from voting on particular item.

Step 3: – In case, the transaction limits specified in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 is surpassed, shareholder approval is required.

The threshold limit specified in Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 is: –

10% or more of the company’s turnover for sale, purchase or supply of goods or materials including the transactions entered through an agent.
10% or more of the company’s net worth for selling, disposing of, or buying any kind of property including the transactions entered through an agent
10% or more of the company’s turnover for leasing of any kind of property
10% or more of the company’s turnover for availing or rendering any services (including services rendered through an agent
The monthly remuneration exceeds ₹2.5 lakh for appointing someone to an office or place of profit in the company, subsidiary, or associate company
The remuneration for underwriting exceeds 1% of the company’s net worth for underwriting the subscription of the company’s securities or derivatives.

Important notes:

These percentages are calculated using the audited turnover or net worth from the previous financial year.
The limits apply to the transaction(s) either singly or added up with any previous similar ones in the same financial year

Disclosure Requirements for Related Party Transactions

Usually, Related Party Transactions for Private Limited Company have certain relaxations but still transparency matters. Ministry of Corporate Affairs has provided certain disclosure requirements that must be complied with by private limited Companies.

Form AOC-2 an annexure of form AOC-4 for filing annual financial statements with ROC is required to be submitted. This form includes the nature of transaction, the amount involved, name(s) of the related party and nature of relationship, Duration and whether the transaction is on arm length basis.

All related party dealings must also be fully disclosed in the financial statements in accordance with accounting standard adopted by the company.

Compliance Checklist: Related Party Transactions for Private Limited Company

Obtain disclosure of interest in form MBP-1
Maintain Register of RPTs in form MBP-4
Disclose RPTs in Board’s Report
Disclose RPTs in financial statements
Ensure proper recording of transactions and timely identification for better compliance.

Conclusion: Related Party Transactions for Private Limited Company

Nowadays, in private limited companies, the promoters possess requisite the awareness about Related Party Transactions but still they are not fully aware of the rules and compliances that apply to their entity structure. Promoters shall take due care of rules and compliances related to RPTs and ensure proper recordkeeping.

It is very important to understand that Related Party Transactions for Private Limited Company are not prohibited by law, but they are regulated in order to prevent conflict of interest and protect interest of minority shareholders.

RPTs entered in good faith at arm length pricing and in ordinary course of business are considered complaint as per the Companies Act, 2013. The promoters shall comply with the legal framework of Related Party Transactions including secretarial standards and accounting standards.

How can My Legal Business LLP help You?

We are team of Company secretaries with expertise in handling corporate matters along with proper record keeping as per the Companies Act, 2013. Our team takes care of whole procedure related to Related Party Transactions for Private Limited Company which consist of: –

identification of related parties
determination of related party transaction
Check arm’s length criteria
Verify ordinary course of business
Check applicability of Section 188
Evaluate thresholds
Obtain Board approval
Pass Board Resolution
Maintain MBP-4 register
Ensure proper documentation
Monitor and review transactions
Check exemptions (if any)

Contact us today to check in to your legal compliance relating to RPTs and just focus on your business operations as we ensure proper and timely compliance.