Related Party Transaction (Detailed)
A related party transaction under Ind AS 24 is any transfer of resources, services, or obligations between an entity and a related party, regardless of whether a price is charged, and requires disclosure of the nature, amount, and terms to allow users of financial statements to assess the arm's length character of the dealing.
Ind AS 24 adopted the definition of related parties broadly. The standard covered subsidiaries, associates, joint ventures, key management personnel and their close family members, entities controlled or significantly influenced by KMP or their close families, and post-employment benefit plans of the reporting entity. This comprehensive scope was designed to capture the full range of relationships through which resources could be transferred on non-market terms.
The practical concern with related party transactions (RPTs) was tunnelling — the extraction of value from a listed entity for the benefit of promoter-controlled private entities. Classic tunnelling routes included inflated purchase prices for raw materials or services procured from promoter-owned vendors, below-market royalty payments for brand or technology licences granted to the listed entity by a promoter holding company, unsecured loans given to group companies at concessional rates, and sale of assets at below-market prices to promoter entities.
SEBI's LODR (Listing Obligations and Disclosure Requirements) Regulations added a market-facing layer on top of Ind AS 24's disclosure requirements. SEBI defined materiality thresholds: any RPT individually exceeding Rs 1,000 crore or 10 percent of annual consolidated turnover, whichever was lower, required prior shareholder approval through an ordinary resolution in which the related party was not allowed to vote. SEBI subsequently tightened these thresholds, moving to 10 percent of net worth or consolidated turnover (whichever was lower), and expanded the definition of related parties for LODR purposes to align more closely with the Companies Act.
The audit committee played the first gate-keeper role. Every RPT, whether material or not by SEBI thresholds, required prior approval from the audit committee. The audit committee was expected to satisfy itself that the transaction was in the ordinary course of business, at arm's length pricing, and not prejudicial to the interests of minority shareholders. SEBI required that the audit committee include at least two-thirds independent directors and that at least one member had financial expertise.
The Companies Act 2013, under Sections 188 and 177, independently imposed restrictions on RPTs involving directors and companies in which directors had interests. Section 188 required board approval, and for transactions exceeding prescribed limits, shareholder approval with the interested director abstaining. The Act also required that every RPT be disclosed in the Board's Report with details of the nature, duration, and amount.
Analysts assessed RPT intensity as a red flag metric. A company conducting a large proportion of its revenue through related parties — procuring from or selling to promoter entities — raised concerns about accurate price discovery and the sustainability of margins. If a promoter entity was the exclusive supplier of a critical raw material to the listed company, the promoter had the ability to transfer profits from the listed entity to the unlisted one by setting prices above market.