1. RELATED PARTY TRANSACTIONS CS Vinayak S Khanvalkar, Partner KANJ & Associates, Company Secretaries Company Law Refresher Course – Pune Branch of WIRC of ICAI 16 th April, 2016 1

2. OBJECTIVES BEHIND REGULATION OF RPT To achieve transparency in dealing with Related Parties Public interest Prevent dwindling or siphoning of Investors/ Stake holders money Prevent misuse of resources Prevent evasion of taxes 2

3. Key changes which have been done in Companies Act, 2013 under related party transactions: Section 297, 299, 314 of the Companies Act, 1956 and certain other provisions merged in 184, 188, 189 of the Companies Act, 2013. CG approval (as per S. 297) has been done away with. Transactions complying dual test i.e. Arms Length and in Ordinary Course of Business are out side the purview of 188(1) The transactions coverage has been widened up, such as leasing of property of any kind, the appointment of any agent for the purchase and sale of goods, material, services or property, holding office or place of profit have been included. Transactions entered into with related parties now to be included in the board’s report along with justification for entering into such contracts and arrangements. 3

4. The penalty for contravention of the provisions of section 297 was covered in general provisions before, but this is now covered specifically in the section itself which also now extends to imprisonment. Additional conditions may be prescribed by the Central Government by Rules. Hence the provisions would be dynamic. Deemed notice for one year in Form 24 AA is not found in new Act. 4

5. Important definitions related to “related party transactions” 2(11) “body corporate” or “corporation” includes a company incorporated outside India, but does not include — (i) a co-operative society registered under any law relating to co-operative societies; and (ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf; 5

6. 2(51) Key managerial personnel” in relation to company means - a)Managing Director or Chief Executive Officer or Manager (CEO and Manager need not be a member of the Board) b)Whole time Director c)Company Secretary. d)Chief Financial Officer. e)Such other officer as may be prescribed* (*No such prescription made till date) 6

7. 2 (69) “promoter” means a person— (a) who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or (b) who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or (c) in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act: Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity; 7

8. 2(76) “related party”, with reference to a company, means— i. a director or his relative; ii. a key managerial personnel 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 and holds along with his relatives, more than two per cent. of its paid-up share capital; * Removal Of Difficulties Order w.e.f 9/7/2014 8

9. (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: Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity; (viii) any company which is— (A) a holding, subsidiary or an associate company of such company; or (B) a subsidiary of a holding company to which it is also a subsidiary; 9

10. (ix) such other person as may be prescribed; For the purposes of sub-clause (ix) of clause (76) of section 2 of the Act, a director or key managerial personnel of the holding company or his relative with reference to a company, shall be deemed to be a related party. 10

11. RELATED PARTY : Sec 2(76) Private Company in which (iv) a. Director or b. Manager = Director / Member Firm in which (iii) a.Director, b.Manager c.a)/ (b) ‘s Relative is a partner Public Company in which (v) (i)Director (ii) Manager and they are Shareholder of >2% paid up capital Singly or along with relatives Natural persons a.Director (i) b.Director's Relative (i) COMPANY c.KMP (ii) d.KMP’s Relative (ii) 11

12. 2 (77) “Relative’’, with reference to any person, means any one who is related to another, if— Person/ Individual Member of HUF Husband / Wife Father/ step- father. Mother/ step- mother Son /Step Son DaughterBrother/ Step Brother Sister/Step Sister Son’s Wife Daughter’s Husband 12

13. Related Party Transactions under Companies Act, 2013 - Practice and Procedures Sec.184: Disclosure of interest by director. Sec.188: Related Party Transactions Sec.189: Register of Contracts Rules Framed under Chapter XII – Meeting of Board And Its Powers Circulars Issued by MCA Also Clause 49 of Listing Agreement 13

14. Sec.184: Disclosure of Interest by Director. What is method of Disclosure of Interest ? Form MBP-1 When to make Disclosure: a)Every director shall at the first meeting of the Board in which he participates as a director b)And thereafter at the first meeting of the Board in every financial year or c)Whenever there is any change in the disclosures already made, then at the first Board meeting held after such change, d)Disclose his concern or interest in any company or companies or bodies corporate, firms, or other association of individuals which shall include the shareholding, in such manner as may be prescribed. 14

15. Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into WITH Body corporate In whichBody corporate In which Such Director (SD) holds more than two per cent. Shareholding (no. of Shs) SD + in association with Other Director (s) holds more than two per cent. shareholding or is a promoter, manager, Chief Executive Officer of that body corporate A firm or other entity in which Such director is a partner, Such director is an owner Such director is a member as the case may be, shall disclose the nature of his concern or interest at the meeting of the Board in which the contract or arrangement is discussed and shall not participate in such meeting : 184(2) if he becomes concerned or interested after the contract or arrangement is entered into, disclose his concern or interest (a)forthwith when he becomes concerned or interested or (b)at the first meeting of the Board held after he becomes so concerned or interested. 184(3) 15

16. Exclusions 184(5) Nothing in this section— (a) shall be taken to prejudice the operation of any rule of law restricting a director of a company from having any concern or interest in any contract or arrangement with the company; (b) shall apply to any contract or arrangement entered into or to be entered into between two companies where any of the directors of the one company or two or more of them together holds or hold not more than two per cent. of the paid-up share capital in the other company. 16

17. RELATED PARTY TRANSACTIONS S. 188 Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and subject to such conditions as may be prescribed, no company shall enter into any contract or arrangement with a related party with respect to— (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 17

18. RELATED PARTY TRANSACTIONS S. 188 (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: Applicable to all companies – including private companies. 18

19. RELATED PARTY TRANSACTIONS S. 188 RPT can be entered into only with the approval of Board of Directors by passing of resolution in the meeting. The agenda of the Board meeting at which the resolution is proposed to be moved shall disclose- (a) the name of the related party and nature of relationship; (b) the nature, duration of the contract and particulars of the contract or arrangement; 19

20. RELATED PARTY TRANSACTIONS S. 188 (c) the material terms of the contract or arrangement including the value, if any; (d) any advance paid or received for the contract or arrangement, if any; (e) the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract; (f) whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and (g) any other information relevant or important for the Board to take a decision on the proposed transaction 20

21. RPTs THAT REQUIRE SHAREHOLDERS’ APPROVAL Sale, Purchase or Supply of goods directly or through an agent Exceeding 10% of Annual Turnover or Rs. 100 crore whichever lower. Selling or otherwise disposing of or buying of property, directly or through an agent Exceeding 10% of Net Worth or Rs. 100 crore whichever lower. Leasing of Property Exceeding 10% of net worth or 10% of the Turnover or Rs. 100 crore whichever lower. Availing or Rendering of services directly or through an agent Exceeding 10% of turnover or Rs. 50 crore whichever lower. Appointment to any office or place of profitMonthly remuneration exceeding Rs. 2,50,000 Remuneration for underwritingExceeding 1% of Net Worth 21

22. RELATED PARTY TRANSACTIONS S. 188 Ordinary Resolution is sufficient to approve RPT. Earlier requirement of special resolution done away with by Companies (Amendment) Act, 2015 w.e.f. 29.5.2015. Further approval of shareholders is not required if the transactions are between holding company and its wholly owned subsidiary whose accounts are consolidated with that of the holding company While passing of the Board Resolution for RPT, the interested Director shall not be present at the meeting. However w.e.f 05.06.2015, in respect of private companies, the interested director may participate after disclosure of his interest. * While passing of the resolution, SUCH related member shall not vote. However w.e.f 05.06.2015, in respect of private companies the member can vote if not directly related. 22

23. RELATED PARTY TRANSACTIONS S. 188 Details of the RPT shall be referred in the Board’s Report and justification for such RPT to be given. * Notification No. GSR 464 (E) dated 5-6-2015 Section 188(3): Where any contract or arrangement is entered into by a director or any other employee, without obtaining the consent of the Board or approval by an ordinary resolution in the general meeting under sub- section (1) 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 authorised by any other director, the directors concerned shall indemnify the company against any loss incurred by it. 23

24. ANSWER THE FOLLOWING QUESTIONS TO ASCERTAIN THE APPLICABILITY OF SECTION 188 Whether the transaction falls under any of the 7 items in Section 188? Whether you are a related party? 24

25. RELATED PARTY TRANSACTIONS S. 188 Exemptions: The following transactions are outside the purview of section 188. –Transactions entered into by the company in its ordinary course of business and –Transactions at arm’s length. –Corporate restructuring transactions (exclusion through MCA clarification). 25

26. What is in the “ordinary course of business?” No precise definition of ordinary course of business. Sales are considered to be in ordinary course of trade when the sales are not affected by any relationship between the buyer and the sellers and are based on commercial considerations and are at Arm’s length. A transaction entered into by the company which is not in an extra ordinary course or in an unusual or abnormal nature, but in the regular routine of the business, then it can be said that the transaction is entered by company is in the “ordinary course of business.” 26

27. Broad factors for determining ordinary course of business Object clause Nature of business and industry History of the transaction Periodicity 27

28. Interpreting “ordinary course of business -Guideline (AML / CFT (Anti-money laundering and countering financing of terrorism) of New Zealand) Whether an activity is in your “ordinary course of business” will depend on your particular business. It is ultimately a question of judgment, which takes into account certain factors. For most businesses, it will be obvious whether an activity they carry on is in their “ordinary course of business”. For example, it is in the ordinary course of business for most retail banks to accept deposits from the public. Some businesses may, however, find it difficult to interpret this phrase. For example, a business that carries out an activity rarely, or in a very limited capacity, or only on certain occasions, may be unsure whether that activity is in its ordinary course of business. 28

29. If you are unsure whether an activity your business carries on is in your “ordinary course of business”, you should consider the following Whether the activity is usual or unusual. - Activities that are very unusual for a business, given its history and normal operations, are less likely to be considered “ordinary”. Various aspects of a business or operation may help you with this analysis. For example, if an activity features in your company’s staff manual and training, or if you have a prescribed procedure for it, it is more likely to be in your ordinary course of business. Likewise, if you advertise the activity, it is more likely to be in your ordinary course of business. 29

30. Whether the activity is frequently carried or not As with all factors set out in this guideline, (AML / CFT) whether an activity occurs frequently will require an assessment of the activity in the context of your business. The more frequent the activity over a period of time, the more likely it is to be an ordinary part of your business. Regularity of the activity How regularly you carry out the activity is also a relevant factor. Regular in this sense means predictable, uniformly occurring and consistent. The more regular an activity, the more likely it is to be in your ordinary course of business. 30

31. Financial scale of the activity The amount of money involved in an activity, proportional to the rest of your business, is also relevant. The more money it involves, the more likely it is to be in the ordinary course of your business. To assess this factor, we suggest you take a period of time and consider the money involved in the activity. Please consider both transaction values and the revenue your business derives from it. This averaging will give a more accurate indication of the nature of the activity in your business. (For the avoidance of doubt, low-value activities may still be an ordinary part of your business, depending on the other factors outlined in this guideline.) 31

32. Resources committed to the activity The more resources an activity consumes, the more likely it is to be in the ordinary course of business. Resources could mean staff time, capital expenditure and/or any other input. Once again, we suggest you take a period of time and consider the resources you commit to the activity in question. For example, if you have a staff member who is permanently involved in a particular activity, it is very likely this activity is an ordinary part of your business. 32

33. What does it offer to customers ? If an activity is involved in the offering of a product or service to customers or third parties, it is much more likely to be considered in the ordinary course of business.. A related, although separate, factor is whether the activity is involved in the generation of revenue. Naturally, an activity is more likely to be in the ordinary course of business if it is carried out with the intention of generating revenue. 33

34. What is Arm’s length price? According to explanation (b) to section 188 (1), Arm’s Length means : –Transaction between two related parties –Conducted as if they were unrelated, so that there is no conflict of interest. 34

35. ARM’S LENGTH PRICE Board of Directors have to decide about the Arm’s Length. –Price: Arm’s Length Price : Domestic Transfer Pricing –Quantum of the transaction. –Terms of Payment –Period of the Transaction. Details of disclosure of interest by director / related party, date of contract / arrangement and brief particulars of the contract / arrangement to be disclosed in the annual return 35

36. Arms’ Length – Some Judgments under Excise We find that the demand is for the period October, 1996 to June, 2000. During this period appellants were clearing the same goods at a higher value to independent buyers than cleared to their subsidiary units. This fact is not in dispute. The appellants were paying duty on the goods cleared to their subsidiary units at the weighted average price which was lower than the value charged to independent buyers. In these circumstances, it cannot be said that the dealings were at arms length. 2013 (294) E.L.T. 329 (Tri. - Mumbai) STERLITE OPTICAL TECHNOLOGIES LTD. Vs COMMR. OF C. EX., AURANGABAD 36

37. Arms’ Length – Some Judgments under Excise Valuation (Central Excise) - Selling goods below cost - Loss making price in wholesale trade - For penetration of market and competing with other manufacturers of similar goods - Not based on manufacturing cost and profit - Spread over five years - HELD : It was extra commercial consideration in fixing of price, and artificially depressed it - Full commercial cost of manufacturing and selling was not reflected in it - It was not ‘normal price’ - Price was not the sole consideration for sale - No prudent business person would continuously suffer huge loss only to penetrate market; they are expected to act with discretion to seek reasonable income, preserve capital and, in general, avoid speculative investments - It is immaterial that no allegation was made that buyer was related person or there was flow back directly from buyer to seller – 2012 (283) E.L.T. 161 (S.C.) COMMISSIONER OF CENTRAL EXCISE, MUMBAI V. FIAT INDIA PVT. LTD. 37

38. Practical Aspects of RPT Circulate MBP 1 / Revised MBP-1/ Annual MBP-1 to the departments concerned e.g. Purchase, Sales, Finance, Accounts and Marketing, HR. Computer Software should put flag to related parties and pop ups be flashed when RP’s Name is entered. Take the recourse to various methods for finding out “arms length price” as prescribed under Custom Valuation Rules, Income Tax TP Rules. RPT shall be routine agenda for Board Meetings to check the limits / whether RPTs are pre approved. Other wise get ratification Keep track whether shareholders’ approval is required for any RPT. Make communication about RPT guidance to client / management / directors on email and keep record secured Guide your clients/ management by effective presentations. 38

39. Sec 189 : REGISTER OF CONTRACTS Entries shall be made in the register on a chronological basis and be authenticated by the CS or any other person authorised by the Board. Register to be placed at Board meeting and signed by all directors at the meeting. Register of contracts in which directors are interested shall remain open at every annual general meeting for inspection by members/proxies. For non-compliance – every director will be liable to a penalty of Rs. 25,000/-. 39

40. CONSEQUENCES OF NON COMPLIANCE 40

41. Section 167: vacation of office 167. (1) The office of a director shall become vacant in case— (a).. (b).. (c) he acts in contravention of the provisions of section 184 relating to entering into contracts or arrangements in which he is directly or indirectly interested; (d) he fails to disclose his interest in any contract or arrangement in which he is directly or indirectly interested, in contravention of the provisions of section 184 ; 41

42. Penalty under Section 184(4) If a director of the company contravenes the provisions of sub-section (1) or subsection (2), such director shall 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. 42

43. Penalty under Section 188 Penalties for directors or any employees: For listed companies: –Imprisonment upto 1 year or –Fine minimum Rs. 25,000 upto Rs. 5,00,000 –Or both. For other companies: –Fine minimum Rs. 25,000 upto Rs. 5,00,000 43

44. Clause 49 of Listing Agreement Related Party Transactions A related party transaction is a transfer of resources, services or obligations between a company and a related party, regardless of whether a price is charged or not. A ‘related party' is a person or entity that is related to the company. Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party, directly or indirectly, in making financial and/or operating decisions and includes the following: 44

45. Clause 49 of Listing Agreement Related Party Transactions A) A person or a close member of that person’s family is related to a company if that person: a. is a related party under Section 2(76) of the Companies Act, 2013;or b. has control or joint control or significant influence over the company; or c. is a key management personnel of the company or of a parent of the company; or 45

46. Clause 49 of Listing Agreement Related Party Transactions B) An entity is related to a company if any of the following conditions applies: a. The entity is a related party under Section 2(76) of the Companies Act, 2013; or b. The entity and the company are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others); or c. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member); or d. Both entities are joint ventures of the same third party; or 46

47. Clause 49 of Listing Agreement Related Party Transactions e. One entity is a joint venture of a third entity and the other entity is an associate of the third entity; or f. The entity is a post-employment benefit plan for the benefit of employees of either the company or an entity related to the company. If the company is itself such a plan, the sponsoring employers are also related to the company; or g. The entity is controlled or jointly controlled by a person identified in (1). h. A person identified in (1)(b) has significant influence over the entity (or of a parent of the entity); or 47

48. Clause 49 of Listing Agreement Related Party Transactions The company shall formulate a policy on materiality of related party transactions and also on dealing with Related Party Transactions. Provided that a transaction with a related party shall be considered material if the transaction / transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds five percent of the annual turnover or twenty percent of the net worth of the company as per the last audited financial statements of the company, whichever is higher. 48

49. Clause 49 of Listing Agreement Related Party Transactions All Related Party Transactions shall require prior approval of the Audit Committee. All material Related Party Transactions shall require approval of the shareholders through special resolution and the related parties shall abstain from voting on such resolutions. 49

50. Clause 49 of Listing Agreement Related Party Transactions The revised Clause 49 would be applicable to all listed companies with effect from October 01, 2014. However, the provisions of Clause 49(VI)(C) shall be applicable to top 100 listed companies by market capitalization as at the end of the immediate previous financial year. The provisions of Clause 49(VII) shall be applicable to all prospective transactions. All existing material related party contracts or arrangements as on the date of this circular which are likely to continue beyond March 31, 2015 shall be placed for approval of the shareholders in the first General Meeting subsequent to October 01, 2014. However, a company may choose to get such contracts approved by the shareholders even before October 01, 2014. 50

51. Clause 49 of Listing Agreement Related Party Transactions VIII. Disclosures A. Related Party Transactions 1. Details of all material transactions with related parties shall be disclosed quarterly along with the compliance report on corporate governance. 2. The company shall disclose the policy on dealing with Related Party Transactions on its website and also in the Annual Report. Disclosures on materially significant related party transactions that may have potential conflict with the interests of company at large. 51

52. Clause 49 of Listing Agreement The role of the Audit Committee shall include the following: Disclosure of any related party transactions Approval or any subsequent modification of transactions of the company with related parties; Review of information by Audit Committee Statement of significant related party transactions (as defined by the Audit Committee), submitted by management; 52

53. COMPARISON BETWEEN SECTION 188 OF COMPANIES ACT 2013 AND AS 18 SECTION 188 2(76) “related party”, with reference to a company, means— i) a director or his relative; ii) a key managerial personnel 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; AS 18 Parties are considered to be related if at any time during the reporting period one party has the ability to –Control the other party or –exercise significant influence over the other party in making financial and/or operating decisions 53

54. SECTION 188 v ) a public company in which a director or manager is a director and holds along with his relatives, more than two per cent. of its paid-up share capital; AS 18 enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries); 54

55. COMPARISON BETWEEN SECTION 188 OF COMPANIES ACT 2013 AND AS 18 SECTION 188 (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: AS 18 associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is an associate or a joint venture 55

56. SECTION 188 Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity; (viii) any company which is— (A) a holding, subsidiary or an associate company of such company; or (B) a subsidiary of a holding company to which it is also a subsidiary; AS 18 individuals owning, directly or indirectly, an interest in the voting power of the reporting enterprise that gives them control or significant influence over the enterprise, and relatives of any such individual; 56

57. 57 ANY QUERIES ?

58. DHANYAWAD 58