When a business buys services from its owner's relative or rents property from a director, the transaction may require additional attention. Understanding related-party transactions helps business owners maintain reliable records, assess tax implications and identify compliance requirements that apply to their business structure.
What Are Related-Party Transactions?
A related-party transaction is a business transaction involving people or entities with a close connection to the business. This relationship could arise through ownership, management, family ties or control over another entity.
For example, a company might purchase raw materials from a business owned by one of its directors. Similarly, a partnership firm could pay rent to a property owned by one of its partners.
These arrangements are not automatically improper. Businesses often work with people they know and trust. The important questions are whether the transaction serves a genuine business purpose, whether its terms are reasonable and whether the necessary records and approvals are in place.
Common Examples Business Owners Should Recognise
Some transactions deserve closer attention because the parties involved have a personal or financial connection.
- Renting property from a relative: A business pays rent for an office or warehouse owned by the proprietor's family member
- Purchasing goods from a connected business: A company sources inventory from another business owned by one of its directors
- Paying for professional services: A business hires a firm in which a director or partner has a financial interest
- Providing loans or financial support: A business lends money to a connected entity or receives funding from an owner, subject to applicable rules
These examples illustrate situations worth reviewing, not a definitive list of transactions that automatically fall under every legal definition. The applicable rules determine which relationships and arrangements qualify.
Do the Rules Apply to Every Business Structure?
The level of regulation depends on how the business is organised.
A sole proprietorship may need to examine payments to relatives when calculating taxable business expenses. However, the proprietor's personal withdrawals are not automatically related-party business transactions.
Partnership firms and limited liability partnerships (LLPs) should pay attention to transactions involving partners or connected persons, including the terms of payments and the supporting documentation.
Companies face more formal requirements. Section 188 of the Companies Act, 2013, covers specified contracts and arrangements between companies and related parties, subject to the section's conditions and exceptions. These can include certain purchases, sales, leases and service arrangements.
Tax rules are a separate consideration. For tax years beginning on or after 1 April 2026, Section 36 of the Income-tax Act, 2025, addresses certain expenses that may be disallowed when payments to specified persons are considered excessive or unreasonable. Earlier periods may fall under the previous legislation.
The key takeaway is that related-party transactions do not trigger identical obligations for every business. Owners should check the rules that apply to their structure and the specific transaction.
Why Should Businesses Track These Transactions?
Maintaining clear records helps business owners understand where money is going and why payments are being made.
1. To support tax deductions
If a business pays a connected person for rent, services or supplies, it should be able to explain the commercial purpose and amount. Appropriate records can help support the expense if it is questioned during a tax review.
2. To improve financial transparency
Transactions involving owners or connected entities can affect how business expenses and financial relationships are understood. Recording them clearly helps prevent confusion during financial reviews.
3. To meet applicable compliance requirements
Certain companies may need to obtain approvals, maintain registers or make disclosures, depending on the transaction and applicable law. Missing a requirement can create avoidable compliance problems.
4. To reduce conflicts of interest
Documenting the arrangement and its terms helps distinguish a genuine business decision from a transaction that primarily benefits a connected individual.
How to Maintain Proper Records
Businesses do not necessarily need a complicated system to begin tracking these arrangements. A consistent process is often enough to identify transactions that require closer review.
- Identify connected parties: Maintain an updated record of relevant owners, directors, partners and connected entities
- Document the business purpose: Record why the transaction was necessary and how it supports business operations
- Keep supporting evidence: Retain contracts, invoices, payment records and relevant quotations
- Check whether the amount is reasonable: Compare the terms with market rates or similar arrangements where appropriate
- Review approval requirements: Confirm whether the business needs a board resolution, shareholder approval or another form of authorisation
- Reconcile the records: Ensure the transaction is reflected correctly in the accounts and any applicable disclosures
For example, suppose a company rents an office from a director for ₹60,000 per month. Keeping the lease agreement, payment records and evidence supporting the rental amount helps explain the arrangement. The company must separately check whether the relevant approval and disclosure rules apply.
When Should You Seek Professional Advice?
Professional advice is particularly useful when a business plans to enter into a significant transaction with an owner, director, partner or relative. It can also help when a connected person owns another business that supplies goods or services to your organisation.
A professional can assess the transaction's commercial terms, identify relevant tax considerations and determine whether specific approval or disclosure requirements apply. This is especially important for companies with multiple directors or entities under common ownership.
If your business needs support reviewing its records and compliance obligations, explore the relevant services offered by P.K. Lakhani & Co.
Why Work With a Professional
As your business grows, knowing when to seek professional financial support can help you stay organised, manage compliance requirements and make more informed decisions. Working with experienced professionals can provide the support needed to handle changing financial responsibilities effectively.
At P.K. Lakhani & Co., we help businesses with:
✅ Audit and assurance services
✅ Accounting and bookkeeping
✅ GST registration and return filing
✅ Tax planning and compliance
✅ Payroll and statutory compliance
✅ Business advisory and financial consulting
Consult Our Experts Today
P.K. Lakhani & Co.
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Conclusion
Transactions involving connected people and businesses are a normal part of commercial activity, but they deserve appropriate attention. Identifying them early, documenting their purpose and checking the applicable requirements can help businesses avoid unnecessary confusion.
A consistent recordkeeping process, supported by professional advice when needed, makes it easier to manage these arrangements responsibly as the business grows.
FAQs
1. What is a related-party transaction?
It is a transaction between a business and a person or entity connected to it through relationships such as ownership, management or family ties, as defined under the applicable rules.
2. Are related-party transactions illegal?
No. They are generally permitted when conducted in accordance with applicable legal requirements. Certain transactions may require approvals, disclosures or additional documentation.
3. Do sole proprietorships need to track related-party transactions?
They should maintain records of business payments to connected persons, particularly where tax treatment or the reasonableness of an expense could be questioned. The applicable requirements differ from those for companies.
4. What does arm's-length pricing mean?
It generally means setting transaction terms as though the parties were independent of each other. For example, a business renting property from a connected person may assess whether the rent is commercially reasonable.
5. What records should businesses maintain?
Depending on the transaction, useful records include contracts, invoices, payment proofs, quotations, explanations of business purpose and required approvals.
6. When should a business consult a chartered accountant?
Seek advice before entering into a significant transaction involving a connected person, or when you are unsure about the applicable tax treatment, approval requirements or disclosures.
Disclaimer: This article is intended for general informational purposes only and should not be treated as legal, tax or accounting advice. The requirements applicable to related-party transactions depend on the business structure, transaction details and relevant law. Consult a qualified professional for advice specific to your circumstances.
Published by: P.K. Lakhani & Co., Chartered Accountants
Tags: Related-Party Transactions, Business Compliance, Tax Compliance, Accounting and Bookkeeping, Business Advisory, Chartered Accountants in Gurugram