By Vikram Mehta | Updated March 2026
What Is a Related Party Transaction?
A Related Party Transaction (RPT) is any contract or arrangement entered into by a company with a person or entity defined as a "related party" under Section 2(76) of the Companies Act, 2013. These transactions — covering everything from the sale of goods to leasing of property to service contracts — require specific approvals under Section 188 of the Companies Act, 2013 because the inherent conflict of interest creates a risk of value being siphoned away from the company and its minority shareholders.
For a foreign company operating an Indian subsidiary, RPT compliance is one of the most consequential governance obligations. Every payment between your overseas parent and the Indian entity — management fees, software licences, shared services, IP royalties, intercompany loans — is a related party transaction. Getting the approval process wrong exposes the Indian subsidiary's directors to penalties of up to INR 25 lakh (for listed companies) or INR 5 lakh (for unlisted companies), and the transaction itself can be declared void.
The RPT framework operates at two levels: the Companies Act, 2013 (applicable to all companies) and SEBI LODR Regulation 23 (additional layer for listed companies). For foreign-owned Indian subsidiaries — typically unlisted private limited companies — the Companies Act requirements are the primary concern, but understanding the SEBI framework matters if you plan a future listing or have a listed Indian partner.
Legal Basis
- Section 2(76) of the Companies Act, 2013 — Defines "related party" to include directors and their relatives, key managerial personnel and their relatives, holding companies, subsidiaries, associate companies, and any firm or private company in which a director or manager is a partner, member, or director.
- Section 188 of the Companies Act, 2013 — Governs the approval mechanism for RPTs. Requires prior board approval for all covered transactions and shareholder approval (ordinary resolution) when transactions exceed prescribed monetary thresholds.
- Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014 — Prescribes mandatory disclosures in the board agenda: name of the related party, nature of the relationship, material terms, value, pricing basis, and any advance paid or received.
- Section 177(4)(iv) of the Companies Act, 2013 — Mandates audit committee approval of RPTs before they are placed before the board.
- SEBI (LODR) Regulations, 2015, Regulation 23 — Imposes additional requirements on listed companies: audit committee pre-approval (only independent directors vote), shareholder approval for material RPTs, half-yearly disclosure to stock exchanges, and omnibus approval framework.
- Sections 92B-92F of the Income Tax Act, 1961 — Transfer pricing provisions that apply when RPTs involve international transactions or specified domestic transactions between associated enterprises.
Who Is a Related Party?
Section 2(76) casts a wide net. For an Indian subsidiary of a foreign company, the following are all "related parties":
| Category | Section 2(76) Clause | Example for Foreign-Owned Subsidiary |
|---|---|---|
| Director or relative of director | (i) | Indian subsidiary's director; director's spouse or parents |
| KMP or relative of KMP | (ii) | CEO, CFO, Company Secretary of the Indian subsidiary |
| Private company where director/manager is a member | (iv) | Another Indian company where your nominee director holds shares |
| Holding company | (viii)(A) | The foreign parent company (e.g., a US or Singapore HoldCo) |
| Subsidiary of holding company (fellow subsidiary) | (viii)(B) | Another subsidiary of the same parent in the UK, Germany, etc. |
| Investing company or venturer | (viii)(C) | A joint venture partner |
| Director/KMP of holding company or their relative | Rule 3, Companies (Specification of Definitions Details) Rules, 2014 | The global CEO sitting on the parent company board |
This means that transactions between your Indian subsidiary and any group entity anywhere in the world are captured, not just transactions with the direct parent.
Types of Transactions Covered Under Section 188
Section 188(1) lists seven categories of transactions that require approval:
| Transaction Type | Threshold for Shareholder Approval | Typical Foreign Subsidiary Example |
|---|---|---|
| (a) Sale, purchase, or supply of goods or materials | Exceeds 10% of annual turnover | Indian sub procures raw materials from parent's group company |
| (b) Selling or buying property of any kind | Exceeds 10% of net worth | Transfer of IP rights from parent to Indian subsidiary |
| (c) Leasing of property | Exceeds 10% of turnover or net worth | Indian sub leases office space from a director's firm |
| (d) Availing or rendering of services | Exceeds 10% of turnover | Management services agreement with the parent company |
| (e) Appointment of agent for purchase/sale | Exceeds 10% of turnover | Parent company acts as distribution agent for Indian sub's products |
| (f) Appointment to office or place of profit | Monthly remuneration exceeds INR 2.5 lakh | Foreign expat appointed as MD of Indian subsidiary at INR 5 lakh/month |
| (g) Underwriting securities or derivatives | Exceeds 1% of net worth | Parent underwrites the Indian sub's debenture issue |
The Arm's Length Exemption
Section 188(1) provides a critical exemption: transactions entered into in the ordinary course of business and on an arm's length basis do not require board or shareholder approval. However, "arm's length" under the Companies Act is broader than just price — it encompasses all commercial terms including credit period, warranties, volume commitments, and payment terms. A transaction at market price but with a 180-day credit period (versus 30 days for unrelated parties) is not arm's length.
In practice, most foreign parent-subsidiary transactions fail the ordinary course of business test because management fee arrangements, IP licences, and shared service agreements are not transactions the Indian subsidiary would enter into with unrelated third parties in the ordinary course. The safe approach is to obtain board approval for all intercompany transactions.
Approval Requirements: Board vs. Shareholders
Step 1: Audit Committee Approval
Under Section 177(4)(iv), every RPT must first be approved by the company's audit committee. The audit committee evaluates the commercial rationale, arm's length pricing, and potential conflict of interest. For listed companies, Regulation 23(2) of SEBI LODR requires that only independent directors on the audit committee vote on RPT approvals.
Step 2: Board Approval
After audit committee clearance, Section 188(1) requires prior approval of the Board of Directors through a resolution at a board meeting. Under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014, the board agenda must disclose: the related party's name, nature of relationship, transaction duration, material terms and value, pricing mechanism, and any advances paid or received. Interested directors must not be present during discussion or voting on the resolution.
Step 3: Shareholder Approval (When Required)
Shareholder approval through an ordinary resolution is required when transactions exceed the monetary thresholds in the table above. For companies with paid-up share capital of INR 10 crore or more, approval by special resolution was previously required (this was later amended to ordinary resolution for most cases). The related party cannot vote on the resolution — in a wholly-owned subsidiary, the resolution passed by the holding company is sufficient.
Omnibus Approval
For repetitive transactions (such as monthly management fees or recurring supply arrangements), the audit committee can grant omnibus approval at the beginning of the financial year. This approval covers transactions up to a specified aggregate value and must be renewed annually. The audit committee must review the actual transactions against the omnibus approval at each quarterly meeting.
SEBI LODR Requirements for Listed Companies
Listed companies face a stricter regime under Regulation 23 of SEBI (LODR) Regulations, 2015:
| Requirement | Companies Act (All Companies) | SEBI LODR (Listed Companies Only) |
|---|---|---|
| Audit committee approval | Required (Section 177) | Required — only independent directors vote (Reg. 23(2)) |
| Board approval | Required (Section 188) | Required |
| Shareholder approval | If thresholds exceeded | If transaction is "material" under scale-based thresholds |
| Materiality threshold | 10% of turnover/net worth | Scale-based: 10% for turnover up to INR 20,000 crore; graded for larger companies (2025 amendment) |
| Half-yearly disclosure | Not required | Required — submit to stock exchanges within 30 days of half-year end |
| Related party definition | Section 2(76) | Broader — includes any person/entity that is a related party under applicable accounting standards (Ind AS 24) |
SEBI's 2025 amendment introduced scale-based materiality thresholds: for entities with turnover up to INR 20,000 crore, a transaction exceeding 10% of consolidated annual turnover is material. For turnover between INR 20,001 crore and INR 40,000 crore, the threshold is INR 2,000 crore plus 5% of turnover exceeding INR 20,000 crore. For turnover above INR 40,000 crore, the threshold is INR 3,000 crore plus 2.5% of excess turnover, capped at INR 5,000 crore.
Transfer Pricing Overlap
Every RPT between a foreign parent and its Indian subsidiary is also an "international transaction" under Section 92B of the Income Tax Act, 1961, subject to transfer pricing regulations. This creates a dual compliance obligation:
- Companies Act arm's length test (Section 188): Evaluates overall commercial fairness of the transaction — price, credit terms, warranties, and business rationale
- Income Tax Act arm's length price (Sections 92-92F): Focuses specifically on whether the price matches what unrelated parties would charge, using prescribed methods (CUP, RPM, CPM, TNMM, PSM)
The Indian subsidiary must file Form 3CEB (transfer pricing audit report) under Section 92E if it has international transactions with associated enterprises. Failure to file attracts a penalty of INR 1,00,000. Maintaining robust transfer pricing documentation — benchmarking studies, functional analysis, and contemporaneous records — satisfies both the Companies Act and Income Tax Act requirements simultaneously.
A common trap: the transfer pricing study shows the management fee is at arm's length, but the company forgets to obtain Section 188 board approval. The transfer pricing report does not substitute for corporate governance approvals.
How This Affects Foreign Investors in India
If you are setting up or operating a foreign-owned subsidiary in India, RPT compliance affects almost every intercompany financial flow:
- Management service agreements: Monthly fees paid to the parent for strategic, IT, HR, or finance support are RPTs requiring board approval and transfer pricing documentation
- IP and royalty payments: Licence fees for using the parent's brand, technology, or patents are RPTs — and also require RBI approval under FEMA if they exceed prescribed percentages
- Intercompany loans: If the parent lends to the Indian subsidiary (or vice versa), the loan terms must be at arm's length and the transaction needs board approval
- Shared services: Cost-allocation arrangements for shared IT infrastructure, accounting centres, or legal teams are RPTs
- Secondment of employees: If the parent seconds an employee to the Indian subsidiary, the reimbursement arrangement is an RPT and may also trigger permanent establishment risk
- Dividend payments: While dividend repatriation to the parent is not an RPT under Section 188 (it is a distribution, not a contract), the declaration of dividend by the subsidiary is a board decision that must consider the interests of all stakeholders
Disclosure Requirements
RPTs must be disclosed in multiple places:
- Board's Report: Under Section 188(2), every RPT approved during the year must be disclosed in the Board's Report in Form AOC-2, including the nature of the transaction, material terms, and rationale
- Annual Return (MGT-7): Details of RPTs form part of the annual return filed with the Registrar of Companies
- Financial Statements: Ind AS 24 (or AS 18 for non-Ind AS companies) requires comprehensive RPT disclosures in the notes to financial statements, including the nature of the relationship, transaction amounts, and outstanding balances
- Statutory Audit Report: The auditor must report on RPTs under CARO 2020 (Clause 3(xv)) and in the audit report
Common Mistakes
- Treating the arm's length exemption as automatic. Many foreign-owned subsidiaries assume that because they have a transfer pricing study showing arm's length pricing, they are exempt from Section 188 approval. The exemption requires both arm's length terms and ordinary course of business — management fees, IP licences, and cost-sharing arrangements are rarely in the ordinary course. Always obtain board approval as a safeguard.
- Forgetting that fellow subsidiaries are related parties. Under Section 2(76)(viii)(B), a subsidiary of your holding company is a related party. If your Indian entity transacts with the parent's UK subsidiary, that is an RPT — even though there is no direct shareholding between the two entities.
- Not recusing interested directors from voting. When the transaction involves the parent company, nominee directors appointed by the parent are "interested" and must abstain from discussion and voting. If all directors are nominees, you need independent directors on the board — or shareholder approval becomes mandatory.
- Conflating Companies Act and transfer pricing arm's length standards. The Companies Act arm's length test considers all commercial terms (credit period, warranties, exclusivity), not just price. A transfer pricing benchmarking study that focuses solely on price does not establish arm's length under Section 188.
- Missing the omnibus approval renewal deadline. Omnibus approvals granted by the audit committee expire at the first AGM following the grant. If you hold your AGM in September but the omnibus was granted in April, transactions after the September AGM without renewal are non-compliant — even if the aggregate value is within limits.
Practical Example
NordTech GmbH, a German industrial automation company, holds 100% of NordTech India Pvt Ltd through its Singapore holding entity, NordTech Asia Pte Ltd. NordTech India has an annual turnover of INR 45 crore and a net worth of INR 12 crore. The following intercompany arrangements exist:
- Management services agreement: NordTech India pays INR 3.6 crore annually (INR 30 lakh/month) to NordTech GmbH for strategic, IT, and HR support. This is 8% of turnover — below the 10% shareholder approval threshold, so only board and audit committee approval is required.
- Technology licence: NordTech India pays a royalty of 5% of net sales (approximately INR 2.25 crore) to NordTech GmbH for use of proprietary software. This is 5% of turnover — board approval suffices.
- Procurement from fellow subsidiary: NordTech India buys INR 6 crore worth of components annually from NordTech Singapore (a fellow subsidiary). This is 13.3% of turnover — exceeding the 10% threshold, triggering shareholder approval. Since NordTech India is a wholly-owned subsidiary, the resolution of the holding company (NordTech Asia Pte Ltd) is sufficient.
NordTech India's compliance steps: (1) The audit committee reviews all three arrangements at the April board meeting and grants omnibus approval for the year with aggregate caps. (2) The board passes resolutions for each arrangement under Section 188 with full Rule 15 disclosures. (3) For the component procurement, a written resolution from NordTech Asia Pte Ltd (as sole shareholder) approves the transaction. (4) The company maintains a transfer pricing study benchmarking all three arrangements using TNMM/CUP methods. (5) Form 3CEB is filed before the income tax return deadline. (6) All transactions are disclosed in Form AOC-2 in the Board's Report and under Ind AS 24 in the financial statements.
Had NordTech India failed to obtain board approval for the management services agreement, the directors who authorised the payment would face a penalty of INR 5 lakh each, and the transaction would be voidable — meaning the company could be forced to recover the INR 3.6 crore already paid to the parent.
Key Takeaways
- Related party transactions under Section 188 cover seven categories of contracts between a company and its directors, KMPs, holding companies, subsidiaries, and other related parties defined under Section 2(76)
- All RPTs require audit committee and board approval; shareholder approval is triggered when transactions exceed 10% of turnover, 10% of net worth, or INR 2.5 lakh monthly remuneration (depending on transaction type)
- The arm's length exemption requires both ordinary course of business and arm's length terms — most parent-subsidiary transactions fail the ordinary course test
- Foreign parent-subsidiary transactions face dual compliance: Section 188 corporate governance approvals and Sections 92-92F transfer pricing documentation, including Form 3CEB
- Penalties for non-compliance are INR 25 lakh per director (listed companies) or INR 5 lakh per director (unlisted companies), plus the transaction is voidable
- SEBI LODR Regulation 23 imposes additional requirements on listed companies, including scale-based materiality thresholds and mandatory half-yearly disclosures
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