Related Party Transactions Harmonising and Reporting Under Various Statutes

Related Party Transactions Harmonising and Reporting Under Various Statutes Gautam Doshi

Related Parties Classification By Purpose For giving a concession Narrow For enforcing Disclosure For noting With Power to rewrite 2

Classification contd. Compliance Approval Regulator Affected Party Stakeholder Self Certification Ban / Prohibit By level Direct Second Level Related to Related Party Third Level often covered Fourth & Higher Level Not normal 3

Classification contd. By source of Relationship Emotional Attachment with / without Control Relatives Economic Interest Fiduciary Interest Control Through Agreement / Law Through Practice Significant Influence Assumed to exist Position Demonstrated by events 4

Classification contd. Can be different at each level By defining Statute Tax / Revenue Related Direct Taxes Indirect Taxes Other Commercial / Economic Regulation Companies Act SEBI Others 5

Relatives Tested persons Income Tax Act Section 2(24)(iv) (Income Benefit or perquisite from Company) 13(3) (Charitable Trust Diversion to Related Parties) Tested Persons Director of a Company Person who has a substantial interest in the Company Author / Founder of Trust / Institution (Individual / HUF / Other) Substantial Contributor (more than Rs.50,000/-) (Individual / HUF / Person) Member of HUF which is Author / Founder / Substantial Contributor Trustee of Trust Manager (by whatever name called) of Institution. 6

Relatives Tested persons Income Tax Act contd. Section Tested Persons 10(5) (Leave Travel Exemption) Individual Employee 17(2)(viii) (Medical Expense & Premium) 40A (2) (Disallowance of excessive expenditure) Individual Employee Individual Partner of Firm Director of Company Member of HUF Member of AOP Substantial Shareholder of Company Director of substantial shareholder 64(1), 64(1A) and 64(2) - clubbing Individual Assessee 56(2)(vii) Taxation of Gifts Individual or HUF (Recipient of Gift / Benefit) 7

Relatives Tested persons Income Tax Act contd. Section 80C(i),(v),(x),(xi) Deduction for Investment 80C (ii) and (xvii) Deduction Annuity & Tuition Fees 80D Deduction Health Insurance 80DD Deduction Person with Disability 92A Transfer Pricing - Associates Tested Persons Individual or HUF Individual Individual or HUF Individual or HUF Individual controlling Enterprise Member of HUF controlling Enterprise 8

Relatives Tested persons Companies Act Section Director Tested Persons 2(76) (Related Party) & 188(Contracting Company) KMP (Companies Act) Manager Director of Holding Company KMP of Holding Company 185 (Lending Company) Director Director of Holding Company AS 18 Para 3 (c) Para 3(d) Individuals owning (directly or indirectly) voting power which gives control or significant influence KMP (Authority and responsibility for planning, directing and controlling) 9

Relatives Tested persons SEBI Provision 2(q) of Take Over Code persons acting in concert 10(1)(a) of Take Over Code (Exemption) Tested Persons Individual shareholder / Acquirer Director of a Company Director of Holding Company Director of any Subsidiary Company Director of any Company under the same management Any person entrusted with the management of the Company Individual Shareholder of an Investment Company holding 10% or more than 10% of the paid up capital Individual Unitholder of a Fund (other than SEBI Registered Mutual Fund) holding 10% or more than 10% of the Unit Capital Individual Shareholder 10

Relatives Tested persons SEBI Provision Clause 49 of the Listing Agreement - 49 (II) (B) Independent Directors Clause 49 of the Listing Agreement 49 (VII) Related party Transactions Tested Persons Director of Company Same as 2(76) of Companies Act plus AS18, that is Director, KMP, Manager, Director of Holding Company, KMP of Holding Company, individuals owning (directly or indirectly) voting power which gives control or significant influence and KMP, that is, individual with Authority and responsibility for planning, directing and controlling the activities of the Company. 11

Relatives Tested persons Central Excise Provision Section 4(1)(a) and (b) rws Expl. (ii) to Sec 4(3) (b) Tested Person Individual Manufacturer Director of Company Trustee Partner Customs Provision Tested Person Section 14 and Valuation Rules Individual Importer 12

Relatives vis-à-vis a Tested persons Concession Provisions contd. Sr. No. Level 1 Level 2 [only Sec56(2)(vii)] Level 3 [only Sec56(2)(vii)] I Spouse [ All provisions except Sec.80C (2) (xvii)] [Sections 10(5), 17(2)(viii), 56(2)(vii), 80C, 80D of IT Act] [Sec. 80DD subject to condition of dependence] [Reg.10(1)(a) of Take Over Code] Lineal Ascendant of Spouse [Parent of Spouse included in 10(1)(a) of Take Over Code] Lineal Descendant of Spouse Brother/Sister of Spouse [Also, for 10(1)(a) of the Take Over Code] Spouse of Lineal Ascendant Spouse of Lineal Descendant Spouse of such Brother / Sister 13

Relatives vis-à-vis a Tested persons Concession Provisions Sr. No. II Level 1 Level 2 [only Sec56(2)(vii)] Brother / Sister Spouse of Brother, [All provisions except 80C, Sister 80D] Level 3 [only Sec56(2)(vii)] - III IV [10(5), 17(2)(viii) and 80DD subject to condition of dependence] Father / Mother [All provisions except 80C, 80D] [10(5), 17(2)(viii) and 80DD subject to condition of dependence] Children [Limited to (2) children for 80C (2)(xvii)] Lineal Ascendant Brother / Sister of Father / Mother Spouse of Children Spouse of such Lineal Ascendant Spouse of such Brother / Sister - [80D and 80DD subject to condition of dependence] Lineal Descendants Spouse of Lineal Descendants 14

Issues Purpose of each concession is different Can the definitions still be combined Relationships one way or two way Gift from Father s Sister ( ) 15 Gift to Father s Sister (?) Ex-Spouse Separated Spouse Domestic Partner

Issues Adopted children Lineal Ascendant / Descendant Step children Companies Act (but not step daughter) Children born out of wedlock Separated Family members Step Father / Mother Companies Act Step brother / Sister Companies Act 16

Relatives Does not include at second level Companies and Firms controlled by first level Persons can enable family arrangements Much wider than Relative as defined Relative does not include levels 2 & 3 except Lineal Ascendants and Descendants. 17

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship 2(24) (iv) + 40A(2) + 2(41) Income Tax 13(3) Sec. 64 "Concern" Provisions Companie s Act AS18 / SEBI 64 2(77) Para 3 + Para 10.9* Central Excise Sec.4 Exp (ii) to sub sec 3(b) Customs SEBI (UK) Expl. II to PAC Rule 2(2) of Valuation Rules Spouse Brother/Sister - Brother/Sister of Spouse - - - - - - Parents - Grand Parents - - - - 18

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship Lineal Ascendants (other than Parents / Grand Parents) 2(24) (iv) + 40A(2) + 2(41) Income Tax 13(3) Sec. 64 "Concern" Provisions Companie s Act AS18 / SEBI 64 2(77) Para 3 + Para 10.9* Central Excise Sec.4 Exp (ii) to sub sec 3(b) Customs (UK) Expl. II to Rule 2(2) of Valuation Rules SEBI PAC - - - - - - Children Grand Children - - - - Lineal Descendants (other than children / Grand children) - - - - - - 19

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship Parents of Spouse Lineal Ascendants of Spouse (other than Parents) Lineal Descendants of Spouse (other than children) Income Tax 2(24)(iv) + 40A(2) + 92A 13(3) Sec. 64 "Concern" Provisions Companies Act AS18/SE BI Central Excise 64 2(77) Para 3 Sec.4 ExpVI(ii) to sub sec 3(B) Customs (UK) Expl.II to Rule2(2) of Valuation Rules SEBI - - - - - - - - - - - - - - - - - - - - - - PAC 20

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship Parents of Spouse of Brother / Sister Spouse of Brother / Sister of Spouse Provisions Income Companies AS18/SE Central Customs SEBI Tax Act BI Excise (UK) 2(24)(iv) + 40A(2) 13(3) Sec. 64 "Concern" 64 2(77) Para 3 Sec.4 ExpVI(ii) Expl.II to Rule2(2) + 92A - - - - - to sub sec 3(B) - of Valuation Rules PAC - - - - - - - - - - - - - Spouse of Lineal Ascendants - - - - - - - - Spouse of Children - - (Son's wife) - - 21

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship 2(24)(iv) + 40A(2) + 92 A Income Tax 13(3) Sec. 64 "Concern" Provisions Companies Act AS18/ SEBI 64 2(77) Para 3 Para 10.9* Central Excise Sec.4 ExpVI(ii) to sub sec.3(b) Customs (UK) Expl. II to Rule2(2) of Valuation Rules SEBI PAC Spouse of Grand Children Spouse of Lineal Descendants (other than Children & Grand Children) - - - - - - - - - - - - - - - Spouse of Lineal Descendants of Spouse - - - - - - - - 22

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions contd. Relationship 2(24)(iv) + 40A(2) + 92 A Income Tax 13(3) Sec. 64 "Concern" Provisions Companies Act AS18/ SEBI 64 2(77) Para 3 Para 10.9* Central Excise Sec.4 ExpVI(ii) to sub sec.3(b) Customs (UK) Expl. II to Rule2(2) of Valuation Rules SEBI PAC Lineal Descendant of Brother/Sister Lineal Descendant of Brother/Sister of Spouse - - - - - - - - - - - - - - - - 23

Relatives vis-à-vis Tested Persons Obligation / Enforcement / Compliance Provisions Relationship Brother / Sister of Parents Spouse of Brother / Sister of Parents Provisions Income Tax Companies AS18 Central Custom SEBI Act /SEBI Excise s (UK) 2(24)(iv) 13(3) Sec. 64 64 2(77) Para 3 + Sec.4 Expl. II to PAC + 40 A(2) + 2(41) "Concern" Para 10.9* ExpVI(ii) to sub sec 3(b) Rule 2(2) of Valuation Rules - - - - - - - - - - - - - - - - Member of HUF - - - - - (?) - HUF - - - - - (?) - * who may be expected to influence, or be influenced by that individual in his / her dealings with the reporting enterprise. 24

Related Parties vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship DIRECT Companies Income-tax Act - Related Transfer Parties 2(76) Pricing 92A & 188 Provisions Income-tax Disallowance 40A(2) SEBI Related Party Excise Customs 1 Independent Director - - - 2 Non Executive non Independent Director - - - 3 Executive Director - - - 4 CEO / Manager - - - - 25

Related Parties vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship DIRECT Companies Act - Related Parties 2(76) & 188 Income-tax Transfer Pricing 92A Provisions Income-tax Disallowance 40A(2) SEBI Related Party Excise Customs 5 Company Secretary - - - - 6 CFO - - - - 7 Holding Company 8 Subsidiary Company 26

Related Parties vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship DIRECT - contd. Companies Income-tax Act - Related Transfer Parties 2(76) Pricing 92A & 188 Provisions Income-tax Disallowance 40A(2) SEBI Related Party Excise Customs 8 Subsidiary Company 9 Associate Company - Company holding > 20% share capital OR Company having control of business decisions-sec 2(6) Company holding >26% of Equity Share Capital OR Company appointing Executive Director Investor Company holding >20% Equity Investor Company holding >25% OR controls >25% of Board - 10 Associate Company - Company in which Company holds / controls >20% Share Capital OR Controls its business decisions Company in which company holds >26% OR Appoints Executive Directors Company holding >20% Equity of Associate Company holding >25% Equity OR Controls >25% of Board - 27

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship DIRECT - contd. Companies Income-tax Act - Related Transfer Parties 2(76) Pricing 92A & 188 Provisions Income-tax Disallowance 40A(2) SEBI Related Party Excise Customs 12 Financier - [51% of assets funded] 13 Guarantor - [10% of total borrowings guaranteed] 14 Technology Provider - [wholly dependent] - - - - - - - - - - - - 29

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship DIRECT - contd. Companies Income-tax Act - Related Transfer Parties 2(76) Pricing 92A & 188 Provisions Income-tax Disallowance 40A(2) SEBI Related Party Excise Customs 15 Raw Materials & Consumables - [ 90% + influence on pricing and terms] 16 Customer - [Influence on pricing and terms] 17 Significant Interest Owner 18 Companies Under the same Management - Firm, AOP, BOI (10% ownership threshold) - - - - - - - - - - - - - - - [very wide] 30

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Sr. No. Relationship SECOND LEVEL 19 Relative of (1), (2) or (3) 20 Relative of (4), (5) or (6) 21 Firm in which Director is a Partner 22 Firm of which Partner exercises control over the Company OR holds >50% of total shares Provisions Companies 92A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - - [Director exercises Control] - - - - - 31

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 23 Firm in which a Manager is a Partner 24 Private Company in which a Director is Director or Member 25 Pivate Company in which a manager is Director or Member Provisions Companies 92A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - 26 Public Company in which Director is Director and holds > 2% Share Capital (along with Relatives) - - 32

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 27 Public Company in which Manager is Director and holds > 2% Share Capital (along with his relatives) 28 Body corporate whose BOD, MD or Manager is accustomed to act in accordance with advice, directions or instructions of a Director Companies Act 2(76) & 188 Provisions 92A 40A (2) SEBI Excise Customs - - - - 29 Body corporate whose BOD, MD or Manager is accustomed to act in accordance with advice, directions or instructions of a Manager - - 33

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 30 Person on whose advice, directions or instructions a Director is accustomed to act Companies Act 2(76) & 188 Provisions 92A 40A (2) SEBI Excise Customs - - - (?) [Entire Board] [Not Advice] - - 31 Person on whose advice, directions on instructions a Manager is accustomed to act - - - (?) [only entities] 32 Fellow subsidiary 33 Fellow subsidiaries through "Group" - - - - - 34

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 34 Fellow subsidiary through any person 35 Director of Holding Company Provisions Companies 92A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - - (entities?) - - 36 KMP of Holding Company 37 Fellow Associate - [Common shareholder / person holding >26% of both companies or appointing Executive Director of both Companies] - - - (entities?) - - [corporate shareholder holding >20% Equity of both companies] - [Individuals plus Relatives or corporate shareholder holding >25% of both companies] [5% common ownership] 35

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 38 Fellow subsidiary through Individual Companies Act 2(76) & 188 Provisions 92A 40A (2) SEBI Excise Customs - [Individual + Relative "control") - 39 Fellow Subsidiary through HUF - [Member + Relative "control"] - - 40 Relative of Substantial Shareholder 41 Director of Substantial Corporate Shareholder - - - - - - - 36

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 42 Associate through Director of Associate holding substantial interest, that is >20% Equity 43 Associate through Director of company holding substantial interest, that is >20% equity in Associate Provisions Companies 92A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - - - - 44 The Other venturer in a Joint Venture in which the Company has interest - - - (?) - - 37

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. SECOND LEVEL 45 Fellow subsidiary through KMP (Executive Director or Deemed Director or Manager holding >50% (owned) in fellow subsidiary Provisions Companies 92A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - 46 Associate through Common KMP (Executive Director or Manager or Deemed Director) - - - 38

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. THIRD LEVEL 47 Firm in which Director's Relative is a Partner 48 Firm in which Manager's Relative is a Partner 49 Private Company in which a Relative of Director is Director or Member (?) 50 Private Company in which Relative of Manager is Director or Member Provisions Companies 92 A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - - - 39

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. THIRD LEVEL 51 Relative of Director of Holding Company or of KMP of Holding Company 52 Relative of Director of Company holding substantial interest, that is >20% Equity Provisions Companies 92 A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - (entity?) - - - 53 Director of Associate through Director of Associate holding >20% equity - - - 40

Relatives vis-à-vis Company Only Obligation / Enforcement / Compliance Provisions Relationship Sr. No. FOURTH LEVEL 54 Associate through Rlative of Director holding substantial interest, that is >20% Equity in Associate 55 Relative of Director of Associate through Director holding >20% Equity. Provisions Companies 92 A 40A (2) SEBI Excise Customs Act 2(76) & 188 - - - - - - 41

Discussion Points Purposes Concessions Regulatory One size cannot fit all Human Race One Origin All related 42

Discussion Points Different attempts to define limited relationships Major 10(5) vs. 56 Minor 13 vs. 56 Relative Generally Base Levels 1,2,3,or 4 Each law / section to adopt acceptable level 43

Discussion Points Practical Considerations Information from Relatives Control over Relatives Hence, Dependence Test Special Provisions where practical considerations absent Sec. 56 level 3 Sec. 13 - (?) 44 Other controls would be more effective

Discussion Points Related Parties Control By ownership By Agreement Defacto Control Preserve Economic Interest Specify objective + Level 45

Discussion Points Areas Not Covered Sec. 185 Insider Trading Different Approaches 92 A vs. SEBI 46

Discussion Points Attack All Non Arm s Length Transactions 80 IA(10) the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business. 47

Discussion Points Benami Transactions Voting on RPT Harmonise SEBI with Companies Act Uncontrolled Related parties Merchant Banker Brokers Bankers 48

Discussion Points Business Partner in a JV Drafting Holding Company Authority to appoint majority of Board Appoint an Executive Director Thresholds 20% / 25% / 26% 49

Discussion Points Disclosures Obligations vis-a-vis specified persons Concept of Group Unworkable Associate Associated Persons Difficult Too wide 50

Discussion Points Concept of accustomed to act in accordance with advice, directions and instructions Can never really be established 2(76) vs. AS18 92A(1) Not enforced Directly or indirectly or through one or more intermediaries Clause (j) three permutations Contrast with Companies Act 2(76) 51

Discussion Points Clause (i) Any customer Clause (e), (f) Executive Director but, not Manager Technology Provider Without exclusive right Raw materials and consumables 40A (2) Member of AOP / Family vs. of Company Prior approval Omnibus Approval 52