Indian companies frequently enter into transactions with group entities, promoters, directors and other related parties. These arrangements may be examined under multiple regulatory frameworks, including the transfer pricing provisions of income tax law and the corporate governance requirements of the Companies Act, 2013.

Although both frameworks refer to the arm’s length principle, their scope, objectives and approval requirements are not identical. A company that relies on a transfer pricing study as its only compliance measure may overlook separate governance obligations.

Section 188 and the Arm’s Length Exemption

Section 188 of the Companies Act, 2013 regulates specified related party transactions, including transactions relating to the sale or purchase of goods, property, leasing, services and other prescribed arrangements.

Such transactions may require approval of the Board of Directors and, where applicable, shareholders, subject to the prescribed thresholds and conditions. Transactions entered into in the ordinary course of business and on an arm’s length basis are generally exempt from certain approval requirements under this provision.

The arm’s length assessment therefore has an important governance function. It helps establish whether the transaction qualifies for the relevant exemption, in addition to supporting the commercial basis of the arrangement.

Audit Committee and Listed Company Requirements

Where applicable, the audit committee must approve related party transactions in accordance with the Companies Act. Omnibus approvals may be available for repetitive transactions, subject to prescribed conditions and the committee’s approval framework.

Listed companies are also subject to the related party transaction requirements under the SEBI Listing Obligations and Disclosure Requirements Regulations. These include additional requirements relating to approvals, materiality and disclosures.

The applicable thresholds and procedures may change through regulatory amendments. Companies should therefore review the current provisions before each approval and reporting cycle.

Why Corporate Governance and Tax Tests May Differ

The transfer pricing provisions primarily examine whether specified transactions between associated enterprises satisfy the arm’s length principle. Company law has a wider governance purpose and may cover domestic related party dealings that do not fall within the scope of international transaction provisions.

The methodologies and documentation used for tax benchmarking are not automatically prescribed as the basis for every company law assessment. Accordingly, a transaction supported by a transfer pricing study may still require separate consideration of its commercial rationale, approval process and governance implications.

This distinction is particularly relevant for domestic transactions involving promoter-group entities and other related parties.

Using Transfer Pricing Analysis in Approval Processes

A well-prepared benchmarking study can provide useful evidence to the Board or audit committee when considering the terms of a related party transaction.

The approval note should identify the relevant transaction, refer to the benchmarking analysis where available and explain the basis for concluding that the terms are appropriate. The date and financial information underlying the study should also be considered, particularly where the transaction is recurring.

Where the pricing or scope of services has changed from the previous year, the reasons should be documented rather than relying automatically on an earlier approval or study.

Consistency in Disclosures and Audit Records

Related party information appears across multiple corporate and tax records, including the register of contracts, Board and committee approvals, financial statement disclosures and the accountant’s report under the Income-tax Act.

Differences in the identification of related parties, transaction descriptions or reported values can lead to audit queries and compliance concerns. Maintaining a consolidated schedule of related parties and transactions can help ensure consistency across these records.

Conclusion

Related party compliance requires more than demonstrating that a transaction is priced at arm’s length. Companies should align their transfer pricing analysis with the applicable approval and disclosure requirements under company law, maintain a consolidated transaction record and ensure that Board approvals, financial statements and tax filings present a consistent account of their related party dealings.