Introduction

Related Party Transactions (RPTs) have long been a focal point for regulatory scrutiny due to their potential for conflicts of interest, transparent disclosures, and governance risks. With recent circular issued by the Securities and Exchange Board of India (SEBI) regarding the comprehensive disclosure and approval requirements for related party transactions (RPTs) undertaken by listed entities and recognized Stock Exchanges, the management of the companies must be proactive in ensuring RPTs meet arm’s length criteria and do not undermine shareholder interests.

Understanding the Arm’s Length Principle in RPTs

The arm’s length price (ALP) ensures that transactions between related entities mirror those between independent businesses, eliminating preferential treatment and financial misreporting. In India, ALP compliance is governed by:

• Companies Act, 2013 (Section 188): Mandates board and shareholder approvals for RPTs exceeding specified thresholds.
• SEBI LODR Regulations, 2015: Stipulates enhanced disclosures and independent approvals for RPTs involving listed entities.
• Income Tax Act, 1961: Enforces Transfer Pricing Regulations for cross-border and domestic transactions, ensuring tax compliance.
• Indian Accounting Standards (Ind AS 24): Requires detailed disclosures of related party relationships and transactions in financial reports.

Non-compliance can result in legal penalties, reputational damage, and financial losses, making it essential for companies to implement robust governance mechanisms.

Regulatory Framework: SEBI LODR and Companies Act

Key Compliance Requirements for RPTs

The table below outlines the key compliance requirements for RPTs under SEBI LODR and the Companies Act, 2013:

1. SEBI LODR Regulations on RPTs

As per the SEBI Circular, effective April 1, 2025, listed entities and recognized Stock Exchanges must obtain prior approval from the Audit Committee and shareholders for RPTs. Additionally, such transactions must be disclosed in the prescribed format, with varying levels of disclosure requirements (comprehensive, limited, or minimum) as applicable.

The primary objective of this regulation is to promote uniformity and transparency in the reporting of RPTs. Accordingly, it is imperative that listed entities ensure all RPTs are conducted on an arm’s length basis, supported by a thorough transfer pricing arm’s length analysis, to ensure compliance with SEBI’s directives.

2. Companies Act, 2013 and RPTs

The Companies Act, 2013 (Section 188) outlines governance requirements for RPTs, including:

• • Board Approval: Mandatory for transactions exceeding specified monetary limits (e.g., sale/purchase of goods or services surpassing 10% of turnover or ₹50 crore, whichever is lower).
  • Shareholder Approval: Required for transactions exceeding prescribed limits, with non-interested shareholders holding the voting power.
  • Third-Party Valuation Reports: Independent assessments are recommended to justify fair market value and avoid pricing disputes.
  • Penalties for Non-Compliance: Directors involved in unfair RPTs can face financial penalties and legal action.

With increased corporate governance activism and SEBI’s heightened oversight, companies must establish rigorous internal compliance frameworks to mitigate risks.

 Challenges in Ensuring Compliance

1. Identifying Related Party Relationships: Expanding definitions mean companies must track direct and indirect related party linkages, especially in conglomerates and cross-border setups.
2. Benchmarking Challenges: Limited availability of comparable transaction data in India makes it challenging to determine fair pricing for RPTs.
3. Operational Constraints: Businesses engaging in intra-group transactions must balance operational efficiency with regulatory mandates.
4. Minority Shareholder Resistance: Ensuring independent shareholder approval can be difficult in promoter-dominated firms.
5. Evolving Regulatory Standards: Companies must constantly adapt to regulatory updates, requiring agile governance structures.

Best Practices for Ensuring Arm’s Length Compliance

1. Implement a Robust Transfer Pricing Framework: Use established methods such as Comparable Uncontrolled Price (CUP), Cost Plus, Resale Price, and TNMM to substantiate RPT pricing.
2. Engage Independent Consultant for Arm’s length analysis Report – Placing the arm’s length report from the independent consultant with detailed benchmarking and justification to the Audit Committee will generate authentication
3. Strengthen Internal Oversight: Form an RPT sub-committee within the audit committee for deeper scrutiny and documentation.
4. Reliance on Market Quotations: The existing requirements demands the management to look for quotations in open market with vendors / companies in similar terms to justify the RPTs.
5. Proactive Shareholder Engagement: Communicating RPT rationale to minority investors fosters trust and avoids governance disputes.
6. Establish a Formal RPT Policy: A documented policy outlining approval processes, risk assessments, and periodic reviews enhances compliance effectiveness.

Future Trends and Strategic Outlook

1. Heightened Regulatory Oversight: SEBI has already introduced detailed disclosure norms which companies need to adhere with Audit Committee wherein specific comments on their agreements / disagreements are required. With the time to come there will be additional responsibilities for the management and Audit Committee.
2. Uniformity and Transparent disclosure: The ultimate aim is not only to report the RPT but enhance consistency and transparency in RPT reporting.
3. Harmonization with Global Standards: Indian regulations are moving towards OECD and IFRS frameworks, increasing governance expectations.
4. Mandatory Cost-Benefit Analysis: Future amendments may require companies to conduct detailed financial impact assessments before executing significant RPTs.
5. Rising Role of Institutional Investors: Activist investors are pushing for greater transparency and independent oversight in RPT approvals.

Conclusion

Given these regulatory requirements for recent SEBI LODR Circular, it is crucial for the management of listed companies to provide information in the prescribed format that gives adequate comfort among Audit Committee members. Simultaneously, Audit Committee members must exercise the highest level of diligence before granting approvals for RPTs.

Ensuring arm’s length compliance for RPTs under SEBI LODR and the Companies Act is no longer optional, it is a critical component of modern corporate governance. Companies that proactively strengthen governance structures, implement independent valuation processes, and adopt data-driven compliance monitoring will not only mitigate regulatory risks but also build stronger investor confidence.

The regulatory landscape will continue evolving, making it essential for organizations to stay ahead of the curve through transparency, proactive stakeholder engagement, and robust compliance frameworks. By institutionalizing best practices, companies can successfully navigate the complexities of related party transactions while fostering sustainable growth and corporate integrity.