Related party relationships are a normal feature of commerce and business. For example, entities frequently carry on parts of their activities through subsidiaries, joint ventures and associates. In those circumstances, the entity has the ability to affect the financial and operating policies of the investee through the presence of control, joint control or significant influence.
For these reasons, knowledge of what constitutes a ˜related party™ under Indian law is imperative to develop an understanding of those transactions which require a higher degree of disclosure than general day-to-day business activities.
The Companies Act, 1956 (the Act) prescribes no precise definition for the term ˜related party™. However Indian Accounting Standard 18 (Related Party Disclosures) issued by the Institute of Chartered Accountants in India (AS 18), defines related parties as 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. For the aforesaid definition, AS 18 further defines ˜Control™ as (a) ownership, directly or indirectly, of more than one half of the voting power of an enterprise, or (b) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise, or (c) a substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise. The term ˜Significant influence™ is defined as participation in the financial and/or operating policy decisions of an enterprise, but not control of those policies.
To further understand this concept, let™s take an example. Herein, a holding company (UH) has two subsidiaries, namely, subsidiary X (SUB X) and subsidiary Y (SUB Y). UH holds 70% of the paid-up share capital of SUB X and 51% paid-up share capital of SUB Y. SUB X in turn holds 30% in Company A (A), 20% in Company B (B) and 51% in Subsidiary X.1 (SUB X.1). As regards UH, the related parties are SUB X, SUB Y and SUB X.1 as UH holds more than one half of the voting power of SUB X and SUB Y, while in case of SUB X.1, UH has Control over SUB X which in turn has direct ownership of more than one-half of the voting power in SUB X.1, therefore UH has indirect control over SUB X.1. Similarly, as regards Sub Y, the related parties are UH and Sub X and X.1 and as regards Sub X, the related parties are UH, Sub Y (fellow subsidiary) and Sub X.1. Also Associates A and B are related parties to Sub X.
Under AS 18, related party includes:
- Enterprises, directly or indirectly, controlled by one or more other enterprises;
- Associates or Joint Ventures of an enterprise;
- Individuals who own interest in the voting power of an enterprise and are in a position to significantly influence the enterprise;
- Key Management Personnel and their relatives;
- Enterprises which share common directors.
However, the following are deemed not to be related parties:
- Two companies simply because they have a director in common (unless the director is able to affect the policies of both the companies in their mutual dealings);
- A single customer, supplier, franchiser, distributor or general agent with whom an enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence);
- The following parties, in the course of their normal dealings with an enterprise by virtue only of those dealings (although they may circumscribe the freedom of action of the enterprise or participate in its decision-making process):
- Providers of finance;
- Trade unions;
- Public utilities;
- Government departments and government agencies (including government sponsored bodies).
It is pertinent to note, that the Companies Bill, 2012 has defined ˜related party™ to mean, with reference to a company, (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 holds along with his relatives, more than two per cent. of its paid-up share capital; (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; (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; (ix) such other person as may be prescribed;
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity. It is to be noted that the Companies Bill, 2012 aims to widen the scope of the existing Act, not only the term ˜related party™ has been clearly elucidated but also stringent disclosure norms have been prescribed for the related party transactions.
Under the Income Tax Act, 1961, while considering the taxable status of transactions, the following have been regarded as related parties: (i) assessee is an individual – any relative of the assessee; (ii) assessee is a company, firm, association of persons or HUF – any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member; (iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual; (iv) a company, firm, association of persons or Hindu undivided family having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member; (v) a company, firm, association of persons or Hindu undivided family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member; (vi) any person who carries on a business or profession, (A) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or (B) where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person.