Introduction
Regulation 23(1) of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements), Regulations, 2015 [‘SEBI (LODR)’] every listed entity shall formulate a policy on materiality of related party transactions and on dealing with related party transactions including clear threshold limits duly approved by the board of directors. Further as per clause (a) to second proviso to sub-regulation (2) of regulation 23 audit committee of a listed entity shall define “material modifications” as part of its policy on materiality of related party transactions. We did a study of materiality policy on related party transactions of the Nifty50 Companies [‘Nifty Group’] with an intent to understand how the term ‘material modifications’ is defined therein, and parameters based on which we can understand what amounts to material modifications and what does not as per the Nifty Group.
Observations – Study of Materiality Policies of Nifty Group
It was observed that amongst Nifty Group few gave a very generic definition of the term ‘Material Modification or subsequent Material Modifications’, in their respective polices on related party transactions while rest some gave a very broader well defined material modifications definition. We have presented our study of Nifty Group based on sectors being part of Nifty Group.
Materiality policies – companies in banking sector
While analysing Related Party Transaction Policy [‘RPT Policy’] of companies belonging to Nifty Group varied practices were observed. A renowned company from the banking sector while defining material modification in its RPT Policy stated that any effect of variation by which the transaction ceases to be in ordinary course and/or on arm’s length shall be considered a material modification. Further it included any change or significant impact in the nature, tenure, value/exposure of any ongoing or proposed related party transaction.
Another company while defining material modification stated that after committing to a contract or agreement for a related party transaction, any alteration that results in a price or rate adjustment exceeding 20% would be considered significant. This applies particularly if the total value of transactions under the contract exceeded 1.00 billion in the preceding financial year or in the ongoing financial year until the modification date. Additionally, contracts or arrangements where consistent pricing or rates are provided to all customers or service providers will not be subject to the criteria for material modification.
Materiality policies – companies in information technology services and consulting sector
Following observations were made with respect to RPT Policy of IT sector companies under Nifty Group.
- Material modification was defined to mean a change in overall pricing or rate under a contract by more than 20%.
- Another company stated that only complete change in the transaction’s nature and in cases of monetary thresholds being more than 10% of the original transaction will be considered as a monetary modification.
- Another IT service provider considered a modification having an adverse financial impact on the company of 10% or more of the originally approved transaction as a material modification
- Materiality policies – companies in insurance sector
One of the leading life insurance companies defined material modifications as any modification in the basis of pricing of an existing RPT having variance more than 25% of the existing approved limit. Another insurance company had defined material modification as variation of 10% or more increase in the original value or consideration of any RPT.
Materiality policies – companies in steel sector
One of the largest steel producer companies defined material modifications as any modification of an existing RPT having a variance of 20% of the current limit as approved by its audit committee.
- Materiality policies – companies in automotive sector
- One automobile manufacturing company defined material modifications as any change in the approved terms which has a financial implication of 25% or more of the contract or Rs 500 crore, whichever being lower.
- Another leading automobile manufacturers defined material modification as any modification made in value/exposure of any ongoing or proposed RPT having an effect of variation by 20% or more or by which the transaction ceases to be in ordinary course and/or on arm’s length.
- Further it was observed that material modification was defined as any modification which would significantly alter the information provided to the audit Committee or change the fundamental nature or basis of the RPT and in case of thresholds which results in an increase of more than 20% from the Budgeted Figures for the Material Related Party Transaction.
- Materiality policies – companies in pharmaceutical sector
Material modification as defined by a leading pharmaceutical company containing an illustrative list rebuttable presumption that a modification is material, if it results in a transaction which has lost its character of being in ordinary course of business, novation of contract or change in nature of transaction, substantial change in terms and conditions of the contract, any variation exceeding 25% over and above the approved limit. It has also provided a list that will not be considered as a material modification which includes changes mandated pursuant to change in law, modification resulting from change in constitution of either of the parties pursuant to scheme of arrangement, modifications which are purely technical and do not result in substantive change or alteration of rights, interests, and obligations of any of the parties.
- Other observations: It was further observed that certain companies in Nifty Group had also stated pointers which would not amount to material modification. Selected observations are quoted below:
- Change in the quantity or rate of existing RPT due to reasons beyond the control of the related parties.
- Change due to revision /imposition of statutory levies like taxes, duties etc.
- Transactions where same pricing is offered uniformly to all customers/counter parties (related/unrelated) shall not be considered as material modification.
- Any changes in related party transactions due to change in provisions of law would not amount to material modification.
- Exercising any right as per terms of original contract shall not be considered as material modification.
- Transaction of a nature which is purely technical and does not result in substantive change or alteration of rights, interests, and obligations of any of the parties, or is uniformly affected for similar transactions with unrelated parties.
Conclusion
On the basis of above analysis, it is observed that definition of material modification would differ depending on nature of business a company carries. Many companies have provided a certain percentage increase in the transaction to be considered as material modification. But there are companies who have not only kept material modification limited to percentage increase in the transaction but has given a broader perspective to material modification including changes in terms and conditions, contracts or transactions not being in ordinary course of business etc. As per reg 23(1) of SEBI LODR board of directors of listed entity shall review RPT policy once in every three years. Business being dynamic and due to everchanging business policies it is advisable that listed entities shall also review the definition of material modification to align the same with changing business practices.
This article is published in Taxmann. The link to the same is as follows: –
This article is written by CS Vallabh M Joshi – Senior Manager – RND Team – vallabhjoshi@mmjc.in
& Ms Isha Jain – Management Trainee – RND Team – ishajain@mmjc.in