A related party transaction is not prohibited; it is regulated. The regulation operates through the approval of the board, the audit committee, and, where the thresholds are exceeded, the shareholders. The failure to obtain the approval does not invalidate the transaction automatically, but it exposes the company and its officers to penalty and the transaction to challenge.
The Approval Matrix
The board's approval is required for every transaction that falls within Section 188(1), unless the transaction is at arm's length and in the ordinary course of business. The audit committee's approval is required for listed companies and for companies covered by Section 177. The shareholders' approval by an ordinary resolution is required where the transaction exceeds the thresholds prescribed by the rules—ten per cent of the turnover or one hundred crore rupees, whichever is lower, for a transaction with a related party.
The Arm's Length and Ordinary Course
The exemption for an arm's length and ordinary course transaction is the most commonly relied upon. The company must maintain a record of the analysis, including the comparable data and the pricing rationale. The board or the audit committee must satisfy itself that the transaction meets both tests.
The Audit
The statutory auditor must examine the related party transactions as part of the audit, and the secretarial auditor must examine the compliance with Section 188. The auditor's report and the secretarial audit report are the public record of the compliance. A transaction that is not disclosed in the board's report or the financial statements is a defect that the auditor must report.
The Common Failure Points
The common failure points are the failure to identify a related party, the failure to obtain the audit committee's approval, the incorrect computation of the threshold, the incomplete AOC-2 disclosure, and the absence of the arm's length documentation. A company that addresses these points before the transaction is entered into avoids the penalty and the challenge.
Call to Action
Anuj Desai & Associates advises companies on the Section 188 approval and audit process—from the identification of the related party and the approval matrix to the arm's length documentation, the AOC-2 disclosure, and the audit defence. If your company has significant related party transactions, we can help you build a compliant record.
📧 office@anujdesaiassociates.com
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🌐 https://anujdesaiassociates.com
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