A loan from the promoter, rent paid to a director's family trust, sales to a group company — every one of these is a "related party transaction," and every one of them is governed by at least three overlapping sets of rules: accounting disclosure, corporate approval, and tax pricing scrutiny.
Three Layers of Compliance
| Layer | Governing Law | What It Requires |
|---|
| Accounting disclosure | Ind AS 24 (or AS 18) | Disclose the nature of relationships, types of transactions, and amounts in the financial statement notes |
| Corporate approval | Section 188, Companies Act 2013 (+ SEBI LODR for listed entities) | Board and/or shareholder approval for specified transactions above thresholds or not at arm's length |
| Tax pricing scrutiny | Section 40A(2), Income Tax Act (+ transfer pricing for international transactions) | Disallowance of "excessive or unreasonable" payments to related persons |
Who Is a "Related Party" Under Ind AS 24?
The Ind AS 24 definition is based on relationships of control or influence, not just shareholding thresholds. It covers:
- Key management personnel (KMP): Directors, CEO, CFO, and other persons with authority and responsibility for planning, directing, and controlling the entity's activities — plus their close family members
- Group entities: Parent, subsidiaries, fellow subsidiaries, and any entity that is part of the same group
- Associates and joint ventures: Of the entity itself, or of any member of its group
- Entities controlled by KMP or their relatives: Even an entity with no direct shareholding link can be a related party if a director's close relative controls it
- Post-employment benefit plans: For the benefit of employees of the entity or a related entity
⚠ Substance over form. A transaction with an entity that has no common directors and no shareholding overlap can still be a "related party transaction" if a director's close family member has significant influence over that entity. Identifying related parties requires looking at actual relationships and influence, not just the company's shareholding register.
What Ind AS 24 Requires to Be Disclosed
For each category of related party, financial statements must disclose:
- The nature of the related party relationship
- The amount of transactions during the period (purchases, sales, services rendered/received, leases, loans, guarantees, etc.)
- Outstanding balances at year-end, including terms and conditions, whether secured, and the nature of consideration to be provided in settlement
- Provisions for doubtful debts related to outstanding balances with related parties, and any expense recognised for bad/doubtful debts from related parties
- Compensation of key management personnel, split into categories (short-term employee benefits, post-employment benefits, other long-term benefits, termination benefits, share-based payments)
Section 188: Board and Shareholder Approval
Section 188 of the Companies Act, 2013 requires board approval (via resolution at a board meeting, not by circulation) for contracts or arrangements with related parties involving matters such as sale/purchase of goods or property, leasing of property, availing or rendering of services, appointment of agents, and appointment to any office or place of profit. For transactions exceeding prescribed thresholds (or not in the ordinary course of business or not on an arm's length basis), shareholder approval by ordinary resolution is also required — with related parties who are interested in the transaction barred from voting. Listed companies face an additional, stricter "material related party transaction" threshold under SEBI LODR Regulation 23, which also requires audit committee pre-approval.
Section 40A(2): The Tax Angle
Even a transaction that is fully approved under Section 188 and properly disclosed under Ind AS 24 is not automatically safe from tax scrutiny. Section 40A(2) of the Income Tax Act allows the assessing officer to disallow expenditure paid to specified related persons (relatives, directors, persons with substantial interest, and their relatives) to the extent it is considered excessive or unreasonable relative to fair market value, legitimate business need, or benefit derived. This makes arm's-length pricing documentation — comparable quotations, market rate benchmarking, or third-party valuations — important even for purely domestic related party transactions, separate from formal transfer pricing documentation required for cross-border transactions.
Practical Checklist for Finance Teams
- Maintain an updated related party register covering directors, KMP, their close relatives, and entities they control or significantly influence — refresh at least annually and whenever board composition changes
- Flag related party transactions at the point of approval, not retrospectively at audit time — this avoids scrambling for board resolutions after the fact
- Maintain pricing benchmarks (market quotes, comparable transactions) for significant related party transactions to support both Section 40A(2) and audit queries
- Reconcile the related party note in the financial statements against the Section 188 register and the audit committee minutes — discrepancies are a common audit observation
Related party transactions often intersect with other compliance areas covered on Finin2min, including balance sheet analysis (related party balances often sit within "other receivables/payables") and MSME payment compliance when a related entity is also a registered MSME supplier.
Frequently Asked Questions
Who is considered a 'related party' under Ind AS 24? ▼
Related parties include persons with control, joint control, or significant influence over the entity (and their close family), key management personnel, group entities (parent, subsidiaries, fellow subsidiaries), associates/joint ventures, post-employment benefit plans, and entities controlled or significantly influenced by any of the above persons. The definition is based on actual relationships and influence, not just shareholding percentages.
What does Section 188 of the Companies Act, 2013 require for related party transactions? ▼
Section 188 requires board approval for specified related party contracts (sale/purchase of goods, leasing, services, agent appointments, etc.), and shareholder approval by ordinary resolution for transactions exceeding prescribed thresholds or not on an arm's length/ordinary course basis, with interested related parties barred from voting. Listed companies face additional audit committee and materiality thresholds under SEBI LODR.
How does Section 40A(2) of the Income Tax Act affect related party transactions? ▼
Section 40A(2) lets the assessing officer disallow expenditure paid to specified related persons if it is excessive or unreasonable compared to fair market value or business need. Even a properly approved and disclosed transaction can face this disallowance, making arm's-length pricing documentation important for domestic related party transactions.