Company Registration

Section 188 of the Companies Act 2013: A Deep Insight

calendar03 Dec, 2022
timeReading Time: 4 Minutes
Section 188 of the Companies Act 2013: A Deep Insight

Every day hundreds of fiscal transactions take place within moderate to large-sized businesses. When an entity or its core members transacts with the relatable business or members, some legal implications come into effect. Sometimes such transactions are used for a fund diversion that largely remains untraceable. That is where Section 188 of the Companies Act 2013 comes into play. The section primarily regularizes the monetary transactions that occur between two related parties. In this article, we will talk about Section 188 of the Companies Act 2013 in detail by delving into different aspects.

Why Does Section 188 Of The Companies Act 2013 Come Into Effect?

Fund diversion is not a part of the ordinary course of business and thus it is hard to trace. Companies use fund diversion in the name of related party transactions for added benefits or sizeable profits without being traced anywhere. This is why Section 188 of the Companies Act 2013 plays such a huge role, as it curbs such conduct and compels companies to instil transparency in their in-house transactions.

What Do You Mean By The Term “Related Party”?

Section 188 of the Companies Act 2013[1] underpins norms around related party transactions. According to Section 2(76) of the Companies Act 2013, the term “Related Party”, in the context of a company, implies;

  • A Director or his/her relative;
  • A core member or his/her relative;
  • A company in which the Director, Manager/his or her relative is a member or Director
  • A private firm in which a Director, Manager/his or her relative is a member or Director
  • A Public Limited Company in which the Director or manager holds the directorship position and, in conjunction with its relative(s) has control over two percent of the company’s paid-up capital.
  • Anybody corporate whose BODs, directors, or MD abide by the directions of the core members such as Director (s) or Manager(s)

What Does Transaction Mean In “Related Party Transaction”?

Any transaction is said to be a Related Party Transaction if it is associated with the;

  • Sale, Purchase, or any supply of particular good;
  • Buying, selling or disposing of the property of any kind;
  • Leasing a property, irrespective of the type
  • Using or facilitating any particular service
  • The hiring of an agent for the sale/buying of goods, services, or property;
  • Such related party placement of any registered office or profit’s place in which the firm, its subsidiary, or associate entity.
  • Underwriting the subscription concerning securities of any type or derivatives thereof of the firm

How to Affirm That a Given Transaction Is a Related Party Transaction under Section 188 of the Companies Act 2013?

Transactions that abide by the following conditions shall be deemed as related party transactions under Section 188 of the Companies Act 2013.

  • Transactions falling under Section 188(1)(a) to (g)
  • Transacting parties under Section (2) 76 read with rule 3 concerning Companies Rules 2014.
  • Transacting party involves a director or KMP of the holding company/his relative for sub-clause (ix) of clause (76) of Section 2 of the Act.

Approvals Required To Bring the Related Party Transactions into Effect

Transactions exceeding the thresholds mentioned under Rule 15 of Companies (Meetings of Board and its Powers) Rules, 2014 cannot come into effect without prior authentication of the company’s members via a resolutions.

S.No Transactions requiring board authentication as per the Companies Act Transactions requiring the company’s approval via resolution as per Company Rules, 2014
  Materials and Goods: Purchase, sale or supply Purchase, sale or supply of goods directly or via an agent that amounts to 10% or more of the turnover or Rs 100 crore, whichever is lower
  Property: Buying, Selling, or Leasing Sale, Purchase of property directly or via an agent that amounts to 10% or more of the net worth or Rs 100 crore, whichever is lower     In case the property’s leasing directly, that amounts to 10% or more of the net worth or Rs 100 crore, whichever is lower.    
  Agent for aforementioned purposes Using or facilitating services directly or via an agent that amounts to 10% or more of the turnover or Rs 100 crore, whichever is lower
  Others i. Accessing or facilitating services ii. Underwriting securities or derivatives thereof iii. Related party’s appointment to a profit’s place or company’s office/subsidiary/associate Iv. If a director or person other than the firm/director/private company/body corporate comes across an amount exceeding the remuneration via company managed by directors and anything in the form of remuneration for others       i. Related party’s selection to the profit’s place or office in the firm/sister concern company/associate where the remuneration exceeds the figure of 2.5 lakhs ii. Underwriting of securities or derivatives thereof when the payment crosses the threshold amounting to 1 percent of the net worth   when payment exceeds 1% of the net worth.    

Note:  For the wholly-owned subsidiary, the resolution passed in the general meeting by the holding company will be adequate for bringing transactions between the wholly-owned subsidiary & the holding company into effect.

What Does The “Ordinary Course Of Business” Imply?

The Companies Act 2013 is yet to clearly define the term “ordinary course of business”. In general, this phrase is used in the context of typical business practices relating to daily affairs and transactions within no hidden aspects whatsoever. The reputable institute ICAI has penned down the following transactions that fall outside the scope of the “ordinary course of business”.

  • Complex Equity Transactions
  • Transactions with foreign companies in areas lacking apt corporate laws
  • If case of nil consideration, the leasing of a business place or facilitation of services by a firm to another company
  • Sales transactions adhering to massive discounts or return
  • Transactions that have arrangements for re-purchase.
  • Contract transactions lacking unalterable terms.

Conclusions

We hope that this write-up has helped you better understand the concept of Related party transactions under Section 188 of the Companies Act 2013. It is important to clearly understand the term “related party” in the context of the governing legislation. According to Section 2(76) of the Companies Act, 2013, the notion of a related party fundamentally revolves around the relative(s) or parties that are closely connected. The phrase “related party transaction” has a significant impact on how companies deal with day-to-day transactions. The section instils transparency in fiscal management and ensures better control over of company’s finances.

Read Our Article: Public Limited Company: Documents and Registration Process

Pankaj Tyagi

Pankaj has a diverse experience of writing research papers, blog, and articles during his college time. Earlier, he was working as a tax consultant in a financial firm, but his interest in writing drives him to pursue a career in the writing field.

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