Exemption for related party transactions

with wholly owned subsidiaries

The Companies Act, 2013 has introduced many new provisions for different types of Companies and one

of the major changes is with regard to the manner of seeking approvals for related party transactions.

Section 188 and Section 177 of the Companies Act, 2013 deal with this subject. For listed companies,

SEBI has additionally made certain amendments to Clause 49 of the Listing Agreement. However, one of

the relieving factors is that SEBI has vide its Circular dated September 15, 2014 introduced an exemption

with regard to related party transactions with wholly owned subsidiaries.

We shall examine this exemption in detail:-

Extract of Clause 49 applicable with effect from October 1, 2014:-

Clause 49(VII)(A) – A related party transaction is a transfer of resources, services or obligations between

a company and a related party, regardless of whether a price is charged.

Clause 49(VII)(C) Proviso - A transaction with a related party shall be considered material if the

transaction / transactions to be entered into individually or taken together with previous transactions

during a financial year, exceeds 10% of the annual consolidated turnover of the company as per the last

audited financial statements of the company.

Clause 49(VII)(D) - All Related Party Transactions shall require prior approval of the Audit Committee.

Clause 49(VII) (E) - All material Related Party Transactions shall require approval of the shareholders

through special resolution and the related parties shall abstain from voting on such resolutions.

Exemption provided vide SEBI Circular dated September 15, 2014:-

The following proviso has been inserted in Clause 49(VII) (E) -

"Provided that sub-clause 49 (VII)(D) and (E) shall not be applicable in the following cases:

(i) transactions entered into between two government companies;

(ii)transactions entered into between a holding company and its wholly owned subsidiary whose

accounts are consolidated with such holding company and placed before the shareholders at the general

meeting for approval.

Position under Companies Act, 2013:-

As per the definition of “related party” under Section 2(76)(viii) of Companies Act, 2013, a subsidiary of

a company shall be a related party of the holding company.

As per Section 188(1), a holding company shall require to take approval of its Board of Directors for

entering into following types of transactions with any of its subsidiaries:-

(a) sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of, or buying, property of any kind;

(c) leasing of property of any kind;

(d) availing or rendering of any services;

(e) appointment of any agent for purchase or sale of goods, materials, services or property;

(f) such related party's appointment to any office or place of profit in the company, its subsidiary

company or associate company; and

(g) underwriting the subscription of any securities or derivatives thereof, of the Company

Further, in case of companies having paid up capital of Rs. 10 crores or more, there is a requirement to

take prior approval of the shareholders of the Company by a special resolution.

As per Section 177 of Companies Act, 2013, Audit Committee needs to be constituted by every listed

company or all public companies:-

(i) With a paid up capital of Rs. 10 crores or more; OR

(ii) Having turnover of Rs. 100 crores or more; OR

(iii) Having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding

Rs. 50 crores or more.

As per Section 177(4), every Audit Committee shall act in accordance with the terms of reference

specified in writing by the Board which shall, inter alia, include

(iv) approval or any subsequent modification of transactions of the company with related parties;

Hence, in case of related party transactions where any of the above mentioned type of Companies is a

party, the approval of the Audit Committee will also be required.

Hence, if a holding company is entering into any of the above mentioned transactions with its wholly

owned subsidiaries, then the requirement of prior approval of Board of Directors and shareholders by

special resolution is applicable, irrespective of whether it is consolidating the accounts of the wholly

owned subsidiary with its accounts or not. Moreover, if the requirement of Audit Committee is

applicable to such Company under Section 177 of the Companies Act 2013, then approval of Audit

Committee is additionally required.

Thus, just by consolidating its accounts and seeking shareholders’ approval, the holding Company can

claim exemption under Clause 49 of Listing Agreement but cannot claim exemption under Companies

Act 2013 only.

In order to claim exemption from the provision of Section 188 of the Companies Act, 2013, such

transactions need to be entered in the ordinary course of business of both the companies and on an

arm’s length basis.

Actionable required by listed holding companies to avail exemption:-

Thus, if a listed holding company is entering into any of the above mentioned transactions with its

wholly owned subsidiaries, then in order to claim exemption under Companies Act, 2013 as well as

Clause 49 of Listing Agreement, the following must be complied:-

1. Such transactions need to be entered in the ordinary course of business of both the companies

and on an arm’s length basis.

2. The accounts of the wholly owned subsidiary must be consolidated with the accounts of the

holding company and placed before the general meeting of the listed holding company

However, if the requirement of Audit Committee is applicable to such Company under Section 177 of

the Companies Act 2013, then the approval of Audit Committee is mandatory for any type of

transactions with related parties.

Hence, if any Company is claiming exemption from seeking approval of Board of Directors as well as

shareholders for a related party transaction, it still needs to seek approval of the Audit Committee for

such transaction, if the requirement of Audit Committee is applicable to such Company under Section

177 of the Companies Act 2013. As of now, there is no provision for claiming exemption from Audit

Committee approval for transactions with related parties.

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