Expert verified
| TL;DR |
| A related party transaction (RPT) is any of seven specific transaction types under Section 188 of the Companies Act, 2013.Related parties include directors, KMP, their relatives, group companies, and certain firms. Board approval is mandatory for every RPT covered under Section 188(1).Shareholder approval is required only when the transaction exceeds prescribed thresholds and is not in the ordinary course or not at arm’s length. Arm’s length pricing must be demonstrated for both Companies Act compliance and Income Tax transfer pricing purposes. All RPTs must be disclosed in the Board’s Report and financial statements regardless of whether approval was required. Form AOC-2 must be annexed to the Board’s Report for all RPTs. Exemption from approval does not exempt you from disclosure. Family-owned manufacturing groups commonly have inter-company sales, leasing, service arrangements, and office of profit appointments. Non-compliance attracts penalties up to ₹25 lakh for listed companies and ₹5 lakh for others, payable by directors personally. Transactions entered into without approval are voidable at the option of the Board or shareholders. PKC provides end-to-end RPT advisory, including diagnostics, approval support, documentation, policy drafting, and ongoing monitoring. |
A related party transaction (RPT) under Section 188 of the Companies Act, 2013 covers seven specific transaction types – such as sales, leasing, and services – with related parties like directors, KMP, and group companies.
Board approval is mandatory for every covered RPT; shareholder approval and disclosure via Form AOC-2 apply once value thresholds are crossed or the deal isn’t at arm’s length.
Related party transactions disclosure is one of the most scrutinised areas of corporate governance and skipping this can mean penalties, voided contracts, or both.
We take you through what counts as a related party transaction, the approval thresholds that trigger shareholder sign-off, and why arm’s length is important for both company law and tax.
You will also learn about disclosure requirements, common RPT structures in family manufacturing groups, penalties for non-compliance, and how we at PKC support RPT compliance.
What Counts as a Related Party Transaction Under Section 188
A related party transaction (RPT) is not defined broadly as a concept under Section 188 of the Companies Act, 2013. Instead, the law lists seven distinct categories of transactions that require compliance when entered into with a related party. These are:
- Sale, purchase, or supply of goods or materials
- Buying, selling, or disposing of property of any kind
- Leasing of property
- Availing or rendering of services
- Appointing an agent for the purchase or sale of goods, property, or services
- Appointing a related party to an office or place of profit in the company, its subsidiary, or its associate
- Underwriting the subscription of securities or derivatives of the company
Loans, guarantees, and investments do not fall under Section 188. These are separately governed by Sections 185 and 186. So, you need to check the right provision depending on the transaction type.
The definition of “related party” comes from Section 2(76) of the Act. The definition covers:
- Directors and their relatives
- Key Managerial Personnel (KMP) and their relatives
- Firms where a director, manager, or their relative is a partner
- Private companies where a director, manager, or their relative is a member or director
- Public companies where a director or manager, along with relatives, holds more than 2% of paid-up share capital
- Holding, subsidiary, and associate companies
- Any person or entity whose advice or directions a director or manager is accustomed to follow
The definition of “relative” under the Act includes spouses, parents, siblings, children, and their spouses, as well as members of a Hindu Undivided Family.
Section 188 of the Companies Act, 2013 applies to all companies in India, whether private or public. It regulates transactions with related parties to prevent insiders from securing unfair benefits at the company’s expense.
However, Section 188(1) does not apply if a transaction is both in the ordinary course of business and at arm’s length. Both conditions must be met. If either is missing, the transaction remains subject to Section 188.
Board and Shareholder Approval Thresholds
You cannot just decide to enter into a related party transaction and inform the board later. The approval process is layered, and each layer has its own role. RPT approval sits within the board’s broader compliance responsibilities – our guide on corporate governance in India covers the full set of Companies Act and SEBI LODR obligations boards need to track.
Audit Committee Approval
For listed companies, prior approval from the Audit Committee is mandatory for all related party transactions, no exceptions. Only independent directors on the Audit Committee can vote on RPT approvals.
For unlisted companies that are not required to have an Audit Committee, this layer does not apply. In such cases, the Board of Directors assumes direct oversight of related party transactions through its own approval process.
Board Approval
Every contract or arrangement covered under Section 188(1) of the Companies Act, 2013 must be approved by the Board of Directors at a properly convened Board meeting through a formal resolution. Such transactions cannot be approved by passing a circular resolution.
A director who has an interest in the proposed transaction must disclose that interest and must not take part in the discussion or vote on the matter. That director is also not counted for the quorum for that specific agenda item.
Board approval is not required only if both of the following conditions are met:
- the transaction is in the ordinary course of business; and
- the transaction is on arm’s length terms.
If either of these conditions is not satisfied, prior Board approval is mandatory.
Shareholder Approval
Shareholder approval by ordinary resolution is required if a related party transaction under Section 188(1) is not in the ordinary course of business or not on arm’s length terms, and its value exceeds the limits prescribed under Rule 15(3).
Related party shareholders cannot vote on such resolutions, except in certain cases allowed by law. If the required Board or shareholder approval is not obtained, the transaction may be declared voidable by the Board, and the concerned directors may be held liable under Section 188(3).
The thresholds, based on the company’s last audited financial statements, are:
| Transaction type | Threshold requiring shareholder approval |
| Sale, purchase, or supply of goods/materials | 10% of annual turnover or ₹100 crore, whichever is lower |
| Buying, selling, or disposing of property | 10% of net worth or ₹100 crore, whichever is lower |
| Leasing of property | 10% of net worth, 10% of turnover, or ₹100 crore, whichever is lower |
| Availing or rendering of services | 10% of annual turnover or ₹50 crore, whichever is lower |
| Appointment to office or place of profit | Monthly remuneration exceeding ₹2.5 lakh |
| Underwriting subscription of securities | Exceeding 1% of net worth |
For listed companies, SEBI LODR Regulations impose stricter materiality thresholds. A material RPT, where the value exceeds ₹1,000 crore or 10% of turnover, requires shareholder approval regardless of whether it is in the ordinary course or at arm’s length.
Note: related parties cannot vote on the shareholder resolution approving an RPT. The only exception is if 90% or more of the members are related parties or promoters.
Also, transactions between a holding company and its wholly owned subsidiary are exempt from shareholder approval requirements.
Arm’s Length Pricing: Why It Matters for Both Companies Act and Tax
The term “arm’s length” appears in both the Companies Act and the Income Tax Act. But they both use it differently.
Companies Act Perspective
Under the Companies Act, the explanation to Section 188(1) defines an arm’s length transaction as “a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest”
The Act does not prescribe specific methods to determine whether a price is at arm’s length. Mostly, companies use comparable market prices, independent valuations, or benchmarking studies to demonstrate that the pricing is fair.
If your transaction is at arm’s length, you may be exempt from Board approval if it is also in the ordinary course of business. If it is not at arm’s length, you need both Board and shareholder approvals (if thresholds are crossed).
Your auditor will also scrutinise whether the pricing is fair. If the company cannot demonstrate arm’s length pricing, it risks the transaction being voidable at the option of the Board or shareholders.
Income Tax Perspective
Chapter X (Sections 92 to 92F) of the Income Tax Act, 1961, governs transfer pricing. The arm’s length price is defined as “the price applied or proposed to be applied between independent enterprises, under uncontrolled conditions”.
The Income Tax Act provides detailed rules for determining arm’s length price. These include:
- Comparable Uncontrolled Price (CUP) method
- Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Profit Split Method (PSM)
- Transactional Net Margin Method (TNMM)
- “Other Method” as prescribed
If your transaction is not at arm’s length, the tax department can make adjustments. For cross-border transactions with non-resident related parties, the difference between the actual price and the arm’s length price is added to your taxable income or disallowed as a deduction.
Section 40A(2) of the Income Tax Act lets an assessing officer disallow any expenditure paid to a related person if it is excessive or unreasonable compared to fair market value.
This applies to a broader set of related persons than Section 188 does, covering directors, partners, relatives, and anyone with a substantial interest of 20% or more in the business. There is no minimum threshold here; even a single inflated invoice to a related party can be picked up in scrutiny.
Overall, you need to satisfy arm’s length pricing under both laws. The Companies Act requires it for approval and disclosure purposes. The Income Tax Act requires it to avoid transfer pricing adjustments, penalties, and interest.
Tip: Maintain documentation supporting your pricing, such as benchmarking studies, valuation reports, market comparables, and other relevant records. Transfer pricing documentation prepared under the Income Tax Act can also support compliance with the Companies Act.
Disclosure Requirements in the Financial Statements and Board Report
Related party disclosure follows these streams:
Accounting Disclosure:
Indian Accounting Standard 24 (Ind AS 24), or AS 18 for companies not under the Ind AS framework, requires you to disclose related party relationships and the transactions with them in the notes to your financial statements.
This includes:
- name of the related party
- nature of the relationship
- transaction amounts
- outstanding balances at year-end
- Provisions for doubtful debts related to such balances
- Expenses recognised for doubtful debts
Disclosure in the Board’s Report:
Section 188(2) requires that every contract or arrangement entered into under Section 188(1) must be disclosed in the Board’s Report. The disclosure must include the justification for entering into the contract or arrangement.
This means your Board’s Report should contain:
- Details of each RPT entered into during the financial year
- The nature of the transaction
- The value of the transaction
- The name of the related party
- Justification for why the transaction was entered into
- Confirmation that the transaction was at arm’s length (or not, with justification)
Form AOC-2:
This is the prescribed form for disclosure of RPTs. It is annexed to the Board’s Report. Form AOC-2 requires you to disclose:
- Details of contracts or arrangements that are not in the ordinary course of business or not at arm’s length
- Details of material RPTs (for listed companies)
- Justification for entering into such transactions
The form also requires you to state whether prior approval was obtained and, if not, whether ratification was sought.
Disclosure under SEBI LODR:
For listed companies, the disclosure requirements are more extensive. SEBI’s Regulation 23 of the LODR Regulations requires every listed company to maintain and publish an RPT materiality policy on its website, disclose material related party transactions to stock exchanges, and secure shareholder approval for material RPTs.
They must also make half-yearly RPT disclosures in a specified format. The audit committee must be provided with comprehensive information before approving any RPT
Note: Companies sometimes assume that if a transaction is exempt from approval requirements (because it is in the ordinary course and at arm’s length), it is also exempt from disclosure. This is not true. All RPTs must be disclosed. The exemption applies only to approval, not disclosure.
Common RPT Structures in Family-Owned Manufacturing Groups
Family-owned manufacturing businesses in India tend to operate through a cluster of related entities rather than a single company, and several recurring structures show up in these groups.
Inter-company sales of raw materials:
Group Company A manufactures raw materials. Group Company B uses those raw materials to manufacture finished goods. The transaction between A and B is an RPT.
If the pricing is not at arm’s length or the transaction is not in the ordinary course, approvals become necessary.
Leasing of land and buildings:
Factory sheds, warehouses, or office premises are frequently owned by a promoter individually, by an HUF, or by a family trust, and leased back to the operating company.
Rent that has stayed the same for a decade while market rates moved is exactly the kind of detail an auditor or tax officer will flag.
Appointment of related parties to office of profit:
Family members are often appointed as directors, managers, or consultants. If the remuneration exceeds ₹2.5 lakh per month, shareholder approval is required.
Even below that threshold, Board approval is mandatory for the appointment itself.
Brand and trademark royalty payments:
Where the family brand is held by a separate entity or an individual promoter and licensed to the operating company, the royalty rate needs commercial justification, since SEBI has historically scrutinised royalty payments as a vehicle for shifting value out of the operating business.
Common service arrangements:
Group entities often share administrative services, IT infrastructure, HR functions, or logistics.
The entity providing the service charges a fee to the recipient entity. This falls under “availing or rendering of services” under Section 188(1)(d).
Loans and advances:
While loans between group companies are covered under other provisions (Section 185 and 186), they also constitute RPTs and require compliance with Section 188 disclosure requirements.
None of these structures are prohibited; they are common features of how Indian family businesses are organised.
The main requirement is that each arrangement is conducted on an arm’s length basis, receives the necessary board or shareholder approvals, and is properly disclosed, rather than being treated as exempt simply because it has long been an established practice.
Practical Challenge:
In a family group, the same individuals often sit on the boards of multiple companies. This means interested directors must abstain from Board meetings when RPTs are discussed. This can make it difficult to achieve a quorum for RPT approvals.
For transactions that are repetitive in nature, the Board (or Audit Committee for listed companies) can grant omnibus approval for a period of up to one year.
This is especially useful for ongoing inter-company transactions like raw material supply or service arrangements. But the omnibus approval must specify:
- The nature of the transaction
- The maximum value
- The basis for pricing
- The related parties involved
Any transaction that exceeds the omnibus limit requires separate approval.
Penalties for Non-Compliance Under Section 188
Non-compliance with Section 188 carries different kinds of penalties:
Civil penalties: Section 188(5) prescribes penalties for directors and employees who enter into or authorise RPTs in violation of the section:
- For listed companies: ₹25 lakh
- For any other company: ₹5 lakh
These penalties are payable by the director or employee personally, not by the company.
Under Section 134(8), failing to disclose the transaction correctly in Form AOC-2 as part of the Board’s Report attracts a penalty on the company of ₹3 lakh.
Every officer in default is liable to ₹50,000, per financial year of non-compliance. As the Tamil Nadu adjudication orders referenced earlier show, these two penalties can apply for each year a company failed to file the form, which adds up quickly across a multi-year default.
Voidability of transactions: Under Section 188(3), any contract or arrangement entered into without the required approvals is voidable at the option of the Board or the shareholders.
The company can recover any loss from the director or employee who entered into or authorised the transaction.
Criminal liability: While Section 188 primarily attracts civil penalties, fraud, deliberate suppression of material facts, or misrepresentation can attract criminal liability under Section 447 of the Act. This can lead to imprisonment and higher fines.
For Listed Companies:
SEBI enforcement under Regulation 23 of the LODR Regulations runs on a separate and stricter track.
In August 2024, SEBI took enforcement action against a group of 27 companies connected to an NBFC over related party loans extended to entities with weak financials, bypassing standard due diligence, resulting in monetary penalties across the group.
The risk is real. Penalties are significant, and enforcement is increasing. Proper documentation, timely approvals, and accurate disclosures are not optional.
PKC’s Related Party Transaction Advisory & Compliance Support
As a trusted CA and management consulting firm, PKC Management Consulting brings both technical depth and the pan-India delivery capability that closely held and family-run manufacturing groups need for RPT compliance. This RPT advisory sits within PKC’s broader Governance, Risk & Compliance services, which help family-owned groups build the board processes and controls that RPT compliance ultimately depends on.
We offer comprehensive advisory and compliance support to help you manage related party transactions effectively:
Compliance diagnostics: PKC conducts a thorough review of your existing RPTs to identify gaps in approvals, documentation, and disclosures. This includes:
- Mapping all related parties under Section 2(76)
- Reviewing existing RPTs for approval compliance
- Assessing arm’s length pricing documentation
- Verifying disclosure accuracy in Board’s Reports and financial statements
Approval process support: Our experts assist in preparing and presenting RPT proposals to the Audit Committee, Board, and shareholders. This includes:
- Drafting Board resolutions and explanatory statements for shareholder meetings
- Preparing justification memos for transactions not in the ordinary course or not at arm’s length
- Ensuring compliance with voting restrictions
Form AOC-2 and disclosure preparation: PKC prepares Form AOC-2 and ensures that all required disclosures are included in the Board’s Report and financial statements. This helps you avoid the penalties that arise from incomplete or missing disclosures.
Arm’s length pricing documentation: We assist in preparing benchmarking studies and documentation to support your arm’s length position. This documentation serves two purposes: compliance under the Companies Act and defence against transfer pricing adjustments under the Income Tax Act.
RPT policy drafting: PKC drafts comprehensive RPT policies that cover identification of related parties, approval processes, pricing methodology, and disclosure procedures. A well-drafted policy helps you operationalise compliance and reduce the risk of inadvertent violations.
Listed entity compliance: For listed companies, we provide specialised support for SEBI LODR compliance, including materiality assessments, audit committee presentations, and stock exchange disclosures.
Training and awareness: PKC conducts training sessions for boards, audit committees, and finance teams on RPT compliance. This helps your team recognise RPTs early and take appropriate action before transactions are executed.
Ongoing monitoring and support: RPT compliance is not a one-time exercise. PKC provides ongoing monitoring and support to ensure that new transactions receive timely approvals and that annual disclosures are accurate and complete.
FAQs
What transactions count as related party transactions under Section 188?
Section 188 covers seven categories: sale, purchase, or supply of goods/materials; buying, selling, or disposing of property; leasing property; availing or rendering services; agent appointment for goods or property; appointing a related party to an office or place of profit; and underwriting securities. Loans and guarantees fall under Sections 185 and 186 instead.
When does an RPT require shareholder approval, not just board approval?
Shareholder approval by ordinary resolution is needed once the transaction value crosses the thresholds in Rule 15(3), such as 10% of turnover or ₹100 crore for goods, whichever is lower. Below these thresholds, board approval alone suffices, provided the transaction isn’t otherwise exempt as ordinary-course and arm’s length.
Why does arm’s length pricing matter for both Companies Act and tax purposes?
Under the Companies Act, arm’s length pricing combined with ordinary business activity exempts a transaction from Section 188 approval entirely. Under tax law, Section 40A(2) allows disallowance of related-party payments that exceed fair market value. The same benchmarking documentation supports your position under both.
Where must related party transactions be disclosed?
They must appear in the notes to financial statements under Ind AS 24 or AS 18, and in Form AOC-2 attached to the Board’s Report under Section 134(3)(h). Listed companies have additional disclosure obligations to stock exchanges under SEBI’s LODR Regulation 23.
What is the penalty for non-compliance with Section 188?
Entering into an unauthorized RPT carries a penalty of ₹25 lakh for listed companies and ₹5 lakh for other companies under Section 188(5), post the 2020 amendment that removed imprisonment. Separately, failing to disclose the transaction in Form AOC-2 attracts a ₹3 lakh penalty on the company and ₹50,000 per officer in default under Section 134(8).
Do RPTs between two group companies owned by the same family need special treatment?
Yes, transactions between commonly owned or commonly controlled entities still qualify as related party transactions under Section 2(76), regardless of how routine they feel within the family structure. Each one needs proper board approval, arm’s length pricing, and disclosure, unless a specific exemption like the wholly-owned-subsidiary carve-out applies.
