Related party transactions — Section 188 approval and disclosure rules

Related Party Transactions (RPTs) are a normal part of business, especially in closely held companies and corporate groups. A company may purchase goods from a director’s relative, take an office on rent from a group entity, provide services to a subsidiary, or enter into other commercial arrangements with entities connected to its directors or management.

However, because these transactions involve a potential conflict of interest, the Companies Act, 2013 places specific approval, disclosure and record-keeping requirements on companies.

The central provision is Section 188 of the Companies Act, 2013, supported by provisions relating to related parties, Board approval, disclosures and maintenance of registers.

What Is a Related Party Transaction?

A Related Party Transaction is broadly a contract or arrangement between a company and a related party.

Under Section 2(76) of the Companies Act, the definition of “related party” includes, among others:

Director or his/her relative

Key Managerial Personnel (KMP) or their relative

• Certain firms in which a director, manager or relative is a partner
• Certain private companies in which a director, manager or relative has membership/directorship
• Holding, subsidiary and associate companies in specified circumstances

Other entities covered by the statutory definition.

Therefore, companies should identify related parties before entering into transactions, rather than discovering the relationship during the annual audit.

Which Transactions Are Covered Under Section 188?

Section 188 specifically covers contracts or arrangements with related parties relating to:

1️⃣ Sale, Purchase or Supply of Goods

Example:

A company purchases raw materials from a private company owned by a director’s relative.

2️⃣ Sale or Purchase of Property

This includes transactions involving the buying or selling of property with a related party.

3️⃣ Leasing of Property

For example, a company takes its office premises on rent from a director or a related entity.

4️⃣ Availing or Rendering of Services

Examples include:

Accounting services

Consultancy

Management services

IT services

Marketing services

5️⃣ Appointment of Agents

Appointment of a related party as an agent for purchasing or selling goods, materials, services or property.

6️⃣ Office or Place of Profit

Appointment of a related party to an office or place of profit in the company, subsidiary or associate company.

7️⃣ Underwriting

Underwriting the subscription of securities or derivatives of the company by a related party.

These categories are specifically listed under Section 188(1).

Is Board Approval Required?

Yes.

As a general rule, a company cannot enter into a Section 188 related-party contract or arrangement without the consent of the Board of Directors through a resolution passed at a Board meeting, subject to the applicable conditions.

The Board should therefore consider the transaction before it is entered into.

The approval process should ideally document:

Name of related party

Nature of relationship

Nature of transaction

Transaction value

Commercial terms

Duration

Pricing basis

Whether the transaction is at arm’s length

Business justification

When Is Shareholder Approval Required?

Board approval alone is not sufficient for certain transactions.

Where the transaction crosses the prescribed thresholds under Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014, prior approval of the company by a resolution is required.

The relevant thresholds depend on the nature of the transaction—for example, sale/purchase/supply of goods, property transactions, leasing, services and office/place of profit.

Therefore, companies should compare the proposed transaction with the current prescribed thresholds before finalising the approval route.

• Important: The threshold is not a universal ₹ amount for every RPT. It varies according to the type of transaction and applicable rules.

Can the Related Party Vote?

Section 188 generally restricts a related party from voting on the resolution approving the transaction.

However, the Act contains exceptions, including the provision for companies where 90% or more members, in number, are relatives of promoters or related parties.

This makes it important to identify the related party relationship before conducting the general meeting.

What Is an Arm’s Length Transaction?

An arm’s length transaction is a transaction between related parties conducted as though they were unrelated, so that there is no conflict of interest.

In simple terms:

The related party should receive substantially the same commercial treatment that an independent third party would receive in a comparable transaction.

For example, if a company rents an office from a director’s relative, the rent should be commercially justifiable and comparable with market conditions.

Section 188 specifically recognises the concept of an arm’s length transaction.

Does Every RPT Require Shareholder Approval?

No.

This is an important point.

Section 188 requires Board approval for covered transactions, but shareholder approval is triggered where the transaction falls within the prescribed conditions/thresholds.

Also, the Act provides an important exception for transactions entered into in the ordinary course of business and on an arm’s length basis. Such transactions are outside the requirement of Section 188(1) approval.

Example

A company regularly sells its products to a related party as part of its ordinary business and does so on arm’s length commercial terms.

Such a transaction may fall outside the Section 188(1) approval requirement.

However, this does not mean that the transaction can simply be ignored for accounting, disclosure or related-party reporting purposes.

Ordinary Course + Arm’s Length: Why Both Matter

Companies often make the mistake of checking only one condition.

For the Section 188 exemption, the transaction generally needs to be:

Ordinary Course of Business

AND

Arm’s Length

Think of it as:

Ordinary Course ❌ + Arm’s Length ✅

→ Section 188 exemption may not apply.

Ordinary Course ✅ + Arm’s Length ❌

→ Section 188 exemption may not apply.

Ordinary Course ✅ + Arm’s Length ✅

→ Section 188(1) approval exemption may apply.

The specific facts and applicable provisions should always be examined.

Disclosure in the Board’s Report

Section 188 also contains a disclosure requirement.

Contracts or arrangements entered into under Section 188(1) are required to be referred to in the Board’s Report to shareholders along with justification.

This makes the Board’s Report an important part of RPT compliance.

The disclosure should allow shareholders and other stakeholders to understand:

Who the related party is

What the relationship is

What transaction took place

The nature/value of the transaction

Why the transaction was entered into

Register of Related Party Transactions — Section 189

Companies also need to maintain the prescribed register of contracts or arrangements covered by Section 184(2) or Section 188.

The register must contain the required particulars and is to be placed before the next Board meeting and signed by the directors present.

The register is maintained at the company’s registered office and is subject to the inspection requirements specified under Section 189. It is also required to be produced at the commencement of the company’s AGM.

Section 184 vs Section 188 vs Section 189

These provisions are often confused.

Section	Main Purpose
Section 184	Disclosure of interest by directors
Section 188	Approval and compliance for related party transactions
Section 189	Register of contracts/arrangements in which directors are interested

So the compliance chain can broadly be understood as:

Director discloses interest

⬇️

Company identifies related party

⬇️

RPT is evaluated under Section 188

⬇️

Required Board/shareholder approval obtained

⬇️

Transaction recorded in register

⬇️

Required financial/Board Report disclosures made

What About Audit Committee Approval?

For companies that are required to have an Audit Committee, related party transactions are also subject to the Audit Committee framework under Section 177 and applicable rules.

The Audit Committee has responsibility for approval or subsequent modification of transactions with related parties, and the Act permits omnibus approvals subject to prescribed conditions.

Therefore, applicable companies may have an additional layer:

Audit Committee → Board → Shareholders

depending on the transaction and applicable requirements.

What Is Omnibus Approval?

For eligible companies, the Audit Committee may provide omnibus approval for certain related party transactions proposed to be entered into by the company, subject to the prescribed conditions.

This is particularly useful where the company has recurring transactions with related parties.

For example:

Monthly services from group company

Instead of seeking individual approval for every transaction, an eligible company may use the prescribed omnibus approval mechanism.

However, the conditions and limits applicable to omnibus approval must be followed.

What Happens If Approval Was Not Obtained?

Section 188 provides consequences where a transaction is entered into without the required Board/shareholder approval.

If the required approval is not obtained and the transaction is not ratified by the Board or shareholders, as applicable, within three months from the date of entering into the contract or arrangement, the contract/arrangement can become voidable at the option of the relevant authority.

Where the transaction is with a related party to a director or was authorised by another director, the concerned directors can also be required to indemnify the company for losses incurred.

Penalties for Non-Compliance

Non-compliance with Section 188 can have significant consequences.

The Act provides penalties for directors/employees who enter into or authorise transactions in violation of the section.

For a listed company, the statutory consequences can include imprisonment of up to one year and/or a fine ranging from ₹25,000 to ₹5 lakh.

For other companies, the Act provides a fine ranging from ₹25,000 to ₹5 lakh for the concerned director/employee.

This is why RPT compliance should be addressed before the transaction is executed, rather than corrected during the year-end audit.

Practical RPT Compliance Checklist

Before entering into a related party transaction, a company should check:

Identification

• Identify all related parties
• Obtain director/KMP disclosures
• Review group structure

Transaction Review

• Identify nature of transaction
• Check whether it falls under Section 188
• Determine whether it is in ordinary course
• Establish arm’s length basis

Approval

• Audit Committee approval, where applicable
• Board approval
• Shareholder approval, if applicable
• Check related-party voting restrictions

Documentation

• Agreement/contract
• Board resolution
• Shareholder resolution, where required
• Pricing/valuation support
• RPT register

Disclosure

• Financial statement disclosure
• Board’s Report disclosure
• Applicable statutory filings

Example: Rent Paid to Director’s Relative

Suppose a company takes its office premises on rent from the wife of a director.

This should immediately trigger an RPT review because the transaction involves a related party.

The company should examine:

Is the person a related party?

⬇️

Is leasing of property covered under Section 188?

Yes.

⬇️

Is the transaction in ordinary course?

Check facts.

⬇️

Is the rent at arm’s length?

Obtain appropriate market/commercial evidence.

⬇️

Is Board approval required?

Check Section 188 requirements.

⬇️

Does it cross the prescribed threshold?

If yes, check shareholder approval requirements.

⬇️

Record & disclose

Maintain the required register and make applicable disclosures.

Common Related Party Transactions

Transaction	Example
🏢 Rent	Company rents office from director
💼 Services	Group company provides management services
📦 Purchase	Company purchases goods from director’s firm
💰 Loan/financial arrangement	Transaction involving related group entities, subject to applicable provisions
🚚 Sale	Company sells goods to group entity
👔 Remuneration/office	Related party appointed to office/place of profit
🏠 Property	Company purchases property from related party

Note: Not every transaction involving a related party is governed exclusively by Section 188. Other provisions, such as Sections 185 and 186, may also apply depending on the transaction.

7 Common RPT Mistakes

1. “It’s a small transaction, so no approval is required.”

Not necessarily. The nature and applicable thresholds matter.

2. “It’s with a group company, so it’s automatically exempt.”

Incorrect. The transaction must be evaluated under the applicable provisions.

3. “It’s at market price, so nothing needs to be disclosed.”

Arm’s length treatment does not automatically eliminate all disclosure requirements.

4. “We can take approval after entering into the transaction.”

Prior approval should be obtained where the law requires it.

5. “The auditor will handle RPT compliance.”

Management and the Board remain responsible for statutory compliance.

6. “Only listed companies need to worry about RPTs.”

Section 188 applies to companies generally, subject to the Act, rules and applicable exemptions.

7. “RPT means only transactions with directors.”

The statutory definition of related party is much broader.

Key Takeaways

Related Party Transactions are not prohibited under the Companies Act.

The objective of Section 188 is to ensure that transactions involving related parties are properly authorised, commercially justified and transparently disclosed.

The key compliance framework is:

Identify Related Party

⬇️

Identify Transaction

⬇️

Check Ordinary Course & Arm’s Length

⬇️

Audit Committee Approval — where applicable

⬇️

Board Approval

⬇️

Shareholder Approval — where applicable

⬇️

Maintain Register

⬇️

Make Required Disclosures

Frequently Asked Questions

Is every related party transaction prohibited?

No. Related party transactions are permitted, provided the applicable legal requirements are followed.

Is Board approval mandatory for RPTs?

Section 188 generally requires Board consent through a resolution at a Board meeting for covered transactions, subject to the statutory exceptions.

When is shareholder approval required?

It depends on the nature and value of the transaction and the prescribed thresholds under the applicable rules.

Does an arm’s length transaction need approval?

A transaction that is both in the ordinary course of business and on an arm’s length basis is outside the Section 188(1) approval requirement. However, other disclosure requirements may still apply.

Does the company need to maintain an RPT register?

Yes. Section 189 requires companies to maintain the prescribed register for contracts or arrangements covered by Section 184(2) or Section 188.

Can an RPT be approved after it has already been entered into?

Where the required approval was not obtained, the Act provides a limited three-month ratification mechanism, subject to the applicable authority and conditions.

Conclusion

Related Party Transactions are an important part of corporate governance because they directly involve the risk of conflicts of interest.

Section 188 of the Companies Act, 2013 establishes the core framework for approval of specified transactions with related parties, while Section 189 deals with maintaining the related register and the Companies Act also requires relevant disclosures.

For companies, the best approach is not to wait until the statutory audit to identify RPTs. Instead, companies should maintain an updated related-party master, review proposed transactions in advance, obtain the required approvals and preserve supporting documentation.

Proper RPT compliance ultimately provides greater transparency to shareholders and helps the Board demonstrate that transactions with connected parties have been undertaken on a properly considered and commercially supportable basis.

Need Help With Corporate Compliance?

TAXAJ assists businesses with:

• Related Party Transaction Compliance
• Section 188 Review
• Board & Shareholder Resolutions
• MGT-14 Filing, where applicable
• RPT Register & Disclosures
• ROC Compliance
• Annual MCA Compliance
• Accounting & Tax Compliance

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