NFRA Circular on effective communication between auditors and TCWG – Frequently Asked Questions
Team Corplaw | corplaw@vinodkothari.com
Other resources:
NFRA’s Call for a Two-Way Communication: A New Requirement or a Gentle Reminder?
RPTs: Testing Multiyear Contracts for Materiality
– Saloni Khant, Executive | corplaw@vinodkothari.com
It is common for companies to enter into multi-year contracts in its usual business operations, to secure supply of goods or services, access to premises for operations, or for other commercial reasons etc. In the maze of RPT compliances, however, given that the transactions are usually approved by the Audit Committee and/ or shareholders on an omnibus basis, challenges arise on the ideal way of dealing with and taking approval for multi-year contracts.
The relevance of multi-year contracts in the context of RPTs arises for two reasons:
- the value of contract that is required to be taken for the purpose of ascertaining materiality of a contract or transaction, and
- the tenure for which the approval can be taken for such contracts.
Several questions arise:
- Should the entire value of the contract be placed for approval, even if that results in crossing the materiality threshold, and requires going to the shareholders?
- Or can the shareholders’ approval be circumvented by dividing the total contract value into yearly values and taking approval only for the estimated yearly transaction value?
- If so, what happens if the contract is not approved by the AC in any subsequent FY within the tenure of the contract?
- If the total contract value is approved, should the approved value be considered for materiality thresholds again for the next FY?
Divisibility of contracts into smaller relevant units
The crucial point in considering whether a contract requires yearly approval or one single approval valid for the whole contract is based on the “divisibility” of the contract – that is to say, its ability to be divided into smaller units instead of considering the contract as a whole. If it is a single contract for a fixed term, the approval of the contract is approval of the entire exchange of resources/services that takes place over such term.
The divisibility of a contract may be judged against various factors, for instance:
- Tenure of the contract
- Contractual milestones for payment based on performance
- Satisfaction of performance through delivery of goods or services under a contract etc.
We discuss each of these in detail below.
Fixed tenure implies single approval for whole tenure?
Several contracts may have a fixed tenure, but does the fixity of tenure itself implies that such a contract shall be required to be approved through a single approval – valid for the whole tenure of the transaction?
There may be several contracts having a fixed term, but the fixity of term in itself may not be the essential feature in all such contracts. For example, a contract might have been entered into 3 years for supply of certain goods or services. While the tenure of the contract is 3 years, each instance of supply of goods or services constitutes an independent divisible supply in itself. Hence, in such cases, merely based on the tenure of the contract, the indivisibility of such arrangement cannot be argued.
Performance or payment milestones in a contract
In a multi-year contract, there are usually payment milestones based on performance of the contract. For example, a contract for development of software may contain milestones, such as, (i) development of UAT model, (ii) development of final software interface, and (iii) activation of the software etc. While the contract value may be divided based on the three different stages or milestones specified in the contract – it is important to note that the performance of the contract becomes complete only upon activation of the software, and hence, the divisions based on the performance milestones do not have an independent existence. Hence, dividing the contract would not be feasible here.
Performance of contract: delivery of goods or services
The most important factor in considering the divisibility of a contract is the actual performance of the contract. Whether the contract is of such nature that the delivery happens “over a period of time”, or is it such that while the exchange of resources/ services take place over the tenure of the term, the performance may be said to be complete only “at a point of time”.
Period of time v. point of time: drawing reference from Ind AS 115
In order to understand the divisibility of a contract based on ‘period of time’ v/s ‘point of time’- reference may be drawn from its closest equivalent under Ind AS 115 read with its guidance note for the purpose of revenue recognition.
Divisible contracts: satisfaction of performance obligations over a period of time
Ind AS 115 specifies conditions based on which it may be said that the performance obligation is satisfied and revenue is required to be recognised over a period of time: [Para 35]
- The nature of the activity is such that the counterparty is able to enjoy the supply simultaneously as it is made.
- In case an asset is created/ enhanced, it remains within the control of the counterparty during such creation/ enhancement.
- In case the nature of the asset so created is such that it has no alternative use and the payment terms provide that the supplier has a right to payment for supply till date.
Where none of these conditions are satisfied, the performance obligation in the contract is considered to be satisfied at a point in time.
(a) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
The key question here is if the performance of the contract is stopped midway, would the customer still be considered to have benefitted from the performance already done?
For e.g., in a rental agreement, the tenant takes the benefit of the premises simultaneously. Even if the tenancy is terminated midway, it does not take away the benefits already enjoyed by such tenant during the period of the contract, he would remain benefitted for the fulfilled period of tenancy.
This may be compared with a construction agreement, where, in the event of an early termination of the contract, the performance obligations would remain incomplete, with no benefits to the customer for the period of time during which the service has been performed prior to its termination. Even where the work is rerouted to another supplier, it would require substantial rework.
(b) the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced;
The renovation of an office building owned by the customer would amount to a contract over a period of time. The service may be terminated midway and can be completed by another service provider since the control of the asset remains with the owner at all times.
(c) the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
The term ‘an alternative use’ must be considered from the perspective of practical limitations and contractual restrictions. Where the nature of the asset is such that it cannot be redirected to another contract, for example – machinery with unusual specifications cannot be sold to another customer, it is said to not have an alternative use. Even where the resources are portable, but the contractual terms restrict such redirection, there is no alternative use.
In such cases, where a contract is terminated midway, the service provider must have the right to receive payment on quantum meruit basis i.e. the work is sufficiently divisible to assess the payment due to the supplier.
When a contract fulfills any of the three conditions, it satisfies one principle criteria:
Any exit from the contract may require the contractual parties to replace the party, and may have penal consequences, but it is not as if the contract was not performed at all.
Manner of seeking approval
Where the transaction is a single indivisible contract i.e. takes place over a period of time, the IND AS recognises revenue over time by measuring the progress in the performance of the contract[1]. Accordingly, the transaction must be placed in its entirety with its full value for approval before the audit committee, the board of directors and the shareholders (if the materiality threshold is crossed). The transactions placed before all the three bodies must be aligned. Once approved, the actual implementation of the transaction shall come merely for review before the audit committee on a yearly basis in terms of section III.B.5 of the SEBI Master Circular dated January 30, 2026.
An interesting question arises here. Once approved, shall this amount be aggregated with new proposed transactions in the next year? Let us consider an illustration here. The materiality threshold for A Ltd. (listed entity) is Rs. 2000cr. In FY 25-26, A enters into a construction contract (single indivisible multiyear contract) and in FY 26-27, a contract for purchase of goods (one off transaction) with B Ltd for various amounts as tabulated below:
| S. No. | FY 25-26 | FY 26-27 | |||||
| Construction Contract Amt (Rs.) (I) | Whether I is material and approved by shareholders? | Purchase Contract Amt (Rs.) (II) | Whether II is material and needs shareholders’ approval? | Whether (I) and (II) shall be aggregated for materiality threshold? | Does the aggregate of (I) and (II) cross the materiality threshold? | Whether (I) shall be placed for noting before shareholders? | |
| 1 | 1000cr | No | 500cr | No | Yes | No | No |
| 2 | 1000cr | No | 1500cr | No | Yes | Yes | Yes |
| 3 | 1000cr | No | 2300cr | Yes | Yes | Yes | Yes |
| 4 | 3000cr | Yes | 1 | No | No | No | Already approved by the shareholders |
| 5 | 3000cr | Yes | 2500cr | Yes | Not required | Yes | |
For the first 3 cases, the transactions are aggregated for testing the material threshold since transaction (I), even though ongoing in FY 26-27, has never been placed before the shareholders. In effect, in case 2, the actual transactions ongoing with B in FY26-27 are crossing the materiality threshold and thus, must be placed for approval before the shareholders.
In case 3, while Transaction (II) crosses the threshold independently, it is only logical for the shareholders to be apprised of the other ongoing transactions (Transaction I) with the same RP to understand the true position of the transactions between the RP and the listed entity. The Industry Standard Note on RPTs (ISN), anyways, requires this disclosure. [Part A(3)] Read our latest article on the ISN: Repetitive Overhaul: RPT regime to get softer
In case 4, Transaction (I) has already been placed before the shareholders for approval. If its value is aggregated with Transaction (II), even a Rs. 1 transaction will require the approval of the shareholders. The essence of the materiality thresholds is seeking approval for material contracts. Such aggregation would defeat the very intent of the law.
In case 5, Transaction (I) is already approved by the shareholders and Transaction (II) crosses the materiality threshold independently. There arises no question of aggregation.
Thus, the decision of aggregating the value of a single indivisible contract in the previous FY for materiality thresholds in the current FY depends upon
- whether such aggregated value crosses the thresholds in the current FY;
- whether the transaction in the previous FY crossed the thresholds back then.
On the other hand, where the transaction is a divisible contract over a term, the estimated value to be utilised in that particular year may be placed for approval before the audit committee, board of directors and shareholders, as the case may be. In case a material transaction was approved by the audit committee on an omnibus basis, it shall continue to be placed before the shareholders. [Section III.B.5 of the Master Circular]. Since the yearly value of the transaction is being approved and utilised, there arises no question of aggregation of previously approved value with proposed transactions in a new FY.
Specific disclosure of tenure of multi-year projects
The law enables securing transparent approvals for indivisible contracts. The ISN requires an estimated break-up financial year-wise in case of a transaction spanning over multiple years to be placed before the audit committee as well as shareholders, as the case may be [Para A5(5)]. (See our FAQs on the Industry Standard Note)
Further, while disclosing RPTs on a half yearly basis as a part of quarterly integrated filing (governance) to the stock exchange, the Master Circular requires disclosure of the aggregate value of the RPT as approved by the Audit Committee as well as the value of transaction during the reporting period.
Conclusion
With SEBI settling RPT approval related non-compliances for settlement fees running into crores[2], compliance officers need to tread more carefully than ever. Deciding whether a multi year contract should be approved as a whole or in parts remains a crucial decision, particularly in the absence of detailed guidance under Companies Act and SEBI LODR. While accounting standards primarily address revenue recognition and may not directly apply to all RPTs, the principles outlined therein can still offer useful guidance in navigating such situations.
[1] Para 39 of the IND AS 115
[2]https://www.sebi.gov.in/enforcement/orders/feb-2026/settlement-order-in-the-matter-of-kalyani-steels-limited_99922.html
Refer to our other resources:
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RPTs: Do extreme comparables distort arm’s length?
– Saloni Khant, Executive | corplaw@vinodkothari.com
The relevance of “arm’s length assessment” in any related party transaction is non-negotiable. Arm’s length is a consideration that runs across all corporate transactions, including those with unrelated parties. However, where the party itself is at arm’s length, that is, unrelated, the question of the transaction terms being other than arm’s length does not surface. In case of related parties, going by the very nature, the party is not at arm’s length, which is precisely why the need to establish arm’s length arises.
Typically, companies will have hundreds of transactions with unrelated parties. Obviously enough, these hundreds cannot be having a uniform price. It does not require elaboration to say that in business reality, prices have a range, and not a single price. When companies try to justify their impugned transactions with a related party, the practice quite often is to pull one value out of the range of values with unrelated parties, juxtapose that with the proposed RPT, and thus find a justification for the arm’s length.
Is one value out of the range of values sufficient to establish arm’s length? Or does AL have to be the central tendency (that is, a median or modal value) out of the range? This is the point that this article tries to deal with.
Additionally, the article also deals with the meaning of arm’s length beyond pricing, ways of establishing arm’s length where comparables are not available to the company, compliances and consequences pursuant to non arm’s length transactions.
This brings us to the more basic question of what exactly is the “arm’s length terms”, and can it be established based on terms comparable at any specific point of the arm or is it the length of the arm that matters – based on which the middle point of the distribution becomes the ideal indicator of arm’s length.
Meaning of arm’s length: How the regulators define the term?
There is no explicit mention of arm’s length under SEBI LODR. An explanation under section 188 of CA, 2013 refers to the term as follows:
‘The expression “arm’s length transaction” means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest.’
The standards on auditing (SA 550 pertaining to Related Parties) also defines the term as:
A transaction conducted on such terms and conditions as between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.
Therefore, in order to consider a transaction to be at an arm’s length, two elements are important:
- The transaction is undertaken on terms similar to those between unrelated parties, and
- There is no conflict of interest, that is, the transaction is undertaken independently, in the best interest of the entities in question.
Similarity of terms with unrelated parties: are outliers good comparables?
While considering comparables to establish arm’s length, companies often cherry pick a few transactions at similar terms with non RPs. But how difficult is it to engineer a near favourable transaction with a non RP? These transactions may be termed very differently from the majority of the transactions and yet appear to be comparables.
Illustrating the problem with Outliers
Let us consider this illustration where a company sells a product to its non RP customers at varying prices and its RP at Rs. 651. The management presents 4 transactions of series A (Rs. 650) to C (Rs. 652), done with unrelated parties, as comparable transactions, which establish the RPT to be at arm’s length. The audit committee is obviously not doing a full fledged factual examination, and therefore, may not even get into transactions of series D (Rs. 655) to F (Rs. 657) where most (25) of the transactions are placed.
Given the above diversity, can a transaction at Rs. 651, a value at an extreme left of the above frequency distribution, still be an arm’s length value? The key question is – does arm’s length justification come from just one from a range of values, or from the central tendency in the range?
Arm’s length is a question that is not limited to CA or LODR. Arm’s length considerations span over Income-tax law, GST law, audit framework, etc. In fact, corporate governance is all about transacting with arm’s length valuations. We will not even expect corporate laws to provide detailed guidance on whether the arm of the arm’s length can be long enough to pick an extreme value, or does it have to be the elbow of the arm, that is, the hump in the middle.
The Income Tax Laws provides some guidance
The Income Tax Act provides several methods to determine arm’s length pricing for a transaction, of which, one shall pick the most appropriate:
- Comparable Uncontrolled Price Method: Price charged in a comparable uncontrolled transaction is identified and adjusted for differences, if any.
- Resale price method: price at which property/services obtained from an associated enterprise is resold to an unassociated enterprise – adjusted by a normal gross profit margin in a CU transaction, expenses, and differences, if any.
- Cost plus method: Direct/indirect costs are increased by an adjusted mark-up to such costs. Adjusted mark-up is normal gross profit mark-up arising in an uncontrolled comparable transaction adjusted for differences, if any.
- Profit split method: Combined net profit is split amongst enterprises in proportion to relative contributions. Relative contribution is evaluated on the basis of reliable external market data – unrelated enterprises performing comparable functions.
- Transactional net margin method: The net profit margin (computed in relation to costs incurred, sales effected, etc.) arising in a comparable uncontrolled transaction is adjusted for differences.[1]
Where the most appropriate method is any method from (a) to (c) or (e) that leads to several values being possible ALPs, a dataset shall be constructed of such values. This is the guidance we get from Income Tax Rules:
- If the dataset consists of at least 6 values, a range of ALPs shall be considered from the 35th to the 65th percentile of this range.[2]
- If the actual price of the transaction is outside this range, the median of the range shall be considered as the ALP for the purpose of tax assessment[3].
This would easily eliminate the outliers. Cherrypicking of transactions would not work here since the majority of the transactions must be placed as comparables before the audit committee.
What if the transaction is priced at the other extreme of the range, in our example above, say, at a price of Rs. 661. Because the transaction is that of a sale, selling at more than moderate prices is in the interest of the entity. . Yet, the RPT would not be at arm’s length. The Report of the Expert Group on Transfer Pricing Guidelines provides the rationale:
‘It must be emphasised that even a transfer price more favourable to the company than an arm’s length price is problematic. This is so because
(a) valuation is impacted by the possibility that the related party may demand an arm’s length price in the future and
(b) the threat to charge an arm’s length price in future could become a form of poison-pill/blackmail.’
Typically, once a price is determined to be arm’s length, it is arm’s length for either party to the bargain. Arm’s length is all about equilibrium, and equilibrium perfectly balances the interests of either party. The other way of saying this is that what is not arm’s length from the counterparty’s perspective should not usually be arm’s length from the perspective of the other party.
The Indian Judiciary on selection of comparables
The Indian Courts scrutinise comparables used to determine the ALP with a fine tooth comb. In the case of CIT v. Mentor Graphics (Noida) Pvt. Ltd., the ITAT noted how selecting comparables with wide differences in operating margins is faulty. On appeal, the Delhi High Court held that where the profit level indicator of just one comparable out of a set is lower than the tax assessee, the transaction cannot be at arm’s length.
The Global View
The OECD Transfer Pricing Guidelines [Para A.7.3] discourage considering extreme comparables and require the rationale for picking such transactions to be examined. The reason might be a defect in comparability or exceptional conditions being met by an otherwise comparable third party; not dissimilar to engineering favourable transactions with non RP.
The USA’s Electronic Code of Federal Regulations provides that to increase the reliability of comparables, an interquartile range from 25th to 75th percentile of a set of comparables must be used[4]. See Ukraine as well. The Code further provides that arbitrary selection of a comparable that corresponds to an extreme point in the range is unlikely to be at arm’s length.
From the judicial perspective, Courts scrutinize the methodology of determining comparables and disregard those which provide absurd [3] results.[The Coca-Cola Company & Subsidiaries v. Commissioner Of Internal Revenue]
Several other countries consider a range of comparables to determine ALP instead of a single comparable which may fall on the extreme end of a range of comparables. See Norway, Switzerland, Bulgaria.
Other aspects of arm’s length RPTs
Price is, but only, an element in the determination of arm’s length criteria for a transaction. The arm’s length assessment, in fact, is based on all the applicable terms of a transaction, as is customarily offered to an unrelated party, vis-a-vis its comparison with a related party.
An illustrative list of checkpoints for assessing arm’s length for various categories of transactions follow:
| Nature of transaction | Relevant factors for assessment | Examples for discussion |
| Granting of loans | Credit profile of the borrower, Interest rate/basis of arriving at interest rate, Tenure, Security and security cover, Penal charges, Other covenants, Cost of funds to the lender company, End use of loan,Outstanding exposures, | Power Bank Ltd. gives loan to A Pvt. Ltd. a company in which its director holds control without any prepayment charges and to other borrowers with similar profiles with heavy prepayment charges. This failure to levy prepayment charges indicates that the transaction may not be at arm’s length. |
| Providing guarantee in favour of RP | Credit worthiness, Past defaults by the debtor,Obligations undertaken pursuant to guarantee agreement,Margin involved | Nofin Ltd. (a NBFC) has a policy of not providing guarantee on behalf of persons with any default in repayment in the past 3 years. However, it provides a guarantee on behalf of its related party which has defaulted twice in the past 3 years. This indicates that the transaction may not be at arm’s length. |
| Availing borrowings | Cost of borrowing Security covenantsPre payment charges | A Ltd. (RP) lends to B Ltd. on the condition of a security cover of 50% as against requirement of 1.25 X for other borrowers. The security cover is grossly lacking; hence, even if the lending/ borrowing rate is arm’s length, the terms of security are not. |
| Sale of goods | Pricing, Credit terms including advance receipts, Other covenants, Alternative options available | A Ltd. provides a credit period of 4 months to all its customers, except its RPs, where the period extends to over a year. Not only this, past records show that the RP has not paid for earlier sales, and new sales are made without interruption. his unusual credit period indicates that the transaction is not at arms’ length, even though at the same price.. |
| Purchase of goods | Pricing, Credit terms including advance payments, Other covenants, Alternative options available | A Ltd. does not pay in advance for purchase of any goods other than those purchased from its RP. This unusual advance payment indicates that the transaction is not at arms’ length even though at the same price. |
| Lease/ sub-lease of premises | Rent charged (including terms for period increment), Security deposit, Tenure; lock-in period, exit rightsApportionment of common maintenance charges | Y Ltd. has provided a part of its premises on rent to X Ltd. (a subsidiary) without security deposit as against the market practice of 3 months’ deposit. While the rental may be in line with the market, the absence of security deposit indicates that the transaction may not be at arm’s length. |
How about unique transactions which do not have comparables?
Companies usually pick transactions with non RPs to establish arm’s length of RPTs. But as it so often occurs in group structures, how can arm’s length be established where the transaction is carried out exclusively with the RP? Sharing of premises, software, payment of brand usage fees are all transactions that do not have market comparables; the sole reason for carrying out such transactions is the counterparty being a RP.
Arm’s length terms in case of unique transactions is not a problem that does not have a solution. In fact, even in case of unrelated parties, there are often transactions which are tailored, specific or unique in nature. The assessment of fairness of pricing and terms of the transaction gets into several factors:
- Burden and benefit analysis: What is the sacrifice, burden or cost incurred by either party to the transaction, and what is the benefit obtained by either. The idea is to at least equate the benefit with the burden. Consider, for example, the use of brand name or flagship name. The basis for charging a licensing fee is that the user entity gets the advantage of the reputation, brand value or goodwill associated with the flagship name or brand. Instead of a complete greenfield start, it gets the backing of an established name. Hence, the analysis will be: what is the profitability, revenue potential, borrowing cost or other outgo of the entity using the name, as compared to other similar starters which do not have the benefit of the name.
- Cost split: In case of sharing of resources, the possible solution may be to split the costs on the basis of a relevant parameter. The relevant parameter will differ on the basis of the expense: for example, in case of using office space, it may be the headcount. In the case of IT resources, it may be transactional volume. Cost allocation techniques may be used here. Is it important to charge a mark-up on the costs? In our view, no, because neither party is doing resource sharing with a view to mark profits.
- Benchmarking studies: If there are instances of similar or nearly similar transactions, it may be useful to benchmark the transaction against industry similars. The availability of data may be a challenge; but sometimes, even an anecdotal evidence may be useful. This is precisely how one would have got an assurance of fair pricing: for example, if you are engaging a consultant for a complex, one-off project, you would get comfort that you are not being over-charged by asking a few peers.
The simple rule is: if the RPT is originated, negotiated, priced and finalised using the same rigour, discipline, independence of approach and process as would have been deployed in case of any other transaction, we are doing what the law/regulations expect. On the contrary, if it is the relationship which is playing on the transaction, we clearly have an issue.
Conclusion
RPT controls have become an all-time favourite subject of the regulators. The recent surge in actions against the use of abusive RPT structures makes it evident that the relevance of RPT controls is expected to only increase ahead. With arms’ length considerations forming an integral part of RPT controls, moving from cherrypicking comparables to presenting appropriate comparables at the median of the range has become all the more important.
[1] Sec. 92C of the Income Tax Act, 1961 read with rule 10B of the Income Tax Rules, 1962 corresponding to section 165
[2] Rule 10CA(4) of the Income Tax Rules, 1962
[3] Rule 10CA(6) of the Income Tax Rules, 1962
[4] 26 CFR § 1.482-1(2)(iii)(C)
See our other resources:
Shastrarth 29 – Compliance Officer’s risks in Abusive RPT Structures
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Some of our recent resources on the subject:
SEBI approves relaxed norms on RPTs
Moderate Value RPTs : Interplay of disclosure norms and impracticalities
Span of Welspun: Is pledge/unpledge a trade under PIT?
– Payal Agarwal, Partner | corplaw@vinodkothari.com
An August 2025 Informal Guidance by SEBI for Welspun Corp Limited sought to clarify the applicability of contra trade on release of pledge. However, it goes on to say that: “…in case of creation of pledge/ revocation, the beneficial ownership does not change till pledge is invoked”. While the IG was specific to revocation of pledge, this seems to be creating a confusion on the contra trade restrictions on creation of pledge. In this article, we discuss the nature of pledge as a trade, and applicability of trading related restrictions on various stages of pledge. Also see a detailed article on treatment of various stages of pledge as trading under PIT Regulations.
Is pledge a trade?
- Answer is yes
- Trading means dealing in securities in any form [Reg 2(1)(l) of PIT Regulations]
- Explanation to the definition expressly includes “pledging”
- Creation of pledge may be considered equivalent to disposal/ intent to dispose the shares
Is release of pledge a trade?
- Technically, a release (or so-called revocation) of a pledge is also a trade. However, given there is no change in beneficial ownership, there is no concern, at least from a contra trade perspective
- There is no actual acquisition or intent to acquire shares, it is mere restoring back the position as it was prior to the creation of pledge
- The shares are coming back to the person who was the beneficial owner of such shares previously.
Is invocation of pledge a trade?
- No, since invocation of pledge is not at the discretion of the holder of shares
- Invocation results in actual disposal of shares, however, related compliances w.r.t. such shares are undertaken at the stage of creation of pledge itself
Examples to understand contra-trade on pledge
Any opposite trade within 6 months of a prior trade attracts violation of contra-trade, except in case of specific waiver for a bona fide purpose. We discuss various combinations of trades within a span of 6 months to understand whether such trades attract contra-trade restrictions.
| Transaction 1 | Transaction 2 | Is it contra-trade? | Can a waiver be granted by CO? |
| Purchase of shares (Buy) | Creation of pledge (Sell) | Yes, opposite trades within 6 months | Yes, if the DP is able to demonstrate the urgency and bona fide nature of such transaction |
| Creation of pledge (Sell) | Purchase of shares (Buy) | Yes, opposite trades within 6 months | In such a case, it is very difficult to prove bona fide of the subsequent trades of purchase of shares after creation of pledge. |
| Creation of pledge (Sell) | Release of pledge | No, since the release of pledge does not result in an opposite trade per se, it is incidental to the primary trade of pledge creation and only restores back the position as it was prior to creation of pledge. | NA |
| Release of pledge | Creation of pledge with another person (Sell) | No | Yes, if the DP is able to demonstrate the urgency and bona fide nature of the underlying transaction for which the pledge is to be created |
| Purchase of shares (Buy) | Invocation of pledge (Sell) | No, since the invocation of pledge is not at the discretion of the shareholder. The relevant act of disposal of shares is taken into account as a “trade” upon creation of pledge itself, and hence, not considered as “trade” again, upon such invocation. | NA |
| Invocation of pledge (Sell) | Purchase of shares (Buy) | NA |
What is a bonafide purpose in the case of a pledge?
How does the Compliance officer verify/ensure that the purpose of the pledge is bonafide?
There cannot be any sure or one-size-fits-all response to this. Pledge is not for its own sake; pledge for an underlying transaction, which may be margin trading facility, borrowing, etc. The Compliance Officer should see whether that underlying transaction is within the regular business or activity of the pledgor. Whether the pledge is limited to the shares of the listed entity or has other securities? Whether the pledgee is an entity which is engaged in providing similar facilities to several unrelated entities? Whether the timing of the pledge is not indicating the advantage of a price spurt, etc.
Compliances applicable to various stages of pledge
The applicability of contra trade restrictions on the various stages of pledge are tabulated hereunder:
| Stage of pledge | Nature of trade (Acquisition/ Disposal) | Pre-clearance required? | TWC applicable? | Contra-trade restrictions applicable? | Remarks |
| Creation of pledge | Disposal | Yes | No, if the trade is bona fide | Yes | While creation of pledge amounts to trade, exemptions from TWC and contra trade may be availed if the trade is for bona fide purpose. |
| Release of pledge | Acquisition | No | No | No | No change in beneficial ownership, and no actual acquisition/ disposal – mere restoration of the position prior to creation of pledge |
| Notice of invocation of pledge | NA | NA | NA | NA | No dealing in securities, mere notice specifying intent |
| Invocation of pledge | Disposal, however, continuation of the prior action of creation of pledge | No | NA | No | Invocation of pledge is done by the pledgee upon default. Once a pledge is created, the pledgor has no control over the invocation of such pledge upon default. Further, since creation of pledge is itself considered as ‘disposal’, the same shares cannot be considered to have been ‘disposed’ again, upon invocation. |
| Sale of pledged securities | Disposal, however, continuation of the prior action of creation of pledge | No (however, intimation to CO post sale, if not covered by System Driven Disclosure) | NA | No | Sale of pledged securities is done by the pledgee, and is not under the control of the pledgor. Further, since creation of pledge is itself considered as ‘disposal’, the same shares cannot be considered to have been ‘disposed’ again, upon sale. |
NFRA’s Call for a Two-Way Communication: A New Requirement or a Gentle Reminder?
Tagging auditors and TCWG to make amends
– Team Corplaw | corplaw@vinodkothari.com
Introduction
NFRA moved the needle, and it is to be seen if the ocean starts boiling.! A 7th Jan 2026 circular from NFRA, addressed to listed entities and their auditors, seemed like an attention-drawer to standards of auditing which are already there, and yet, the auditing fraternity is holding meetings with boards and senior management of listed entities, to comply with what was always a compliance requirement. Does the 7th Jan circular bring up any new boxes to be ticked, any new procedures to be laid or responsibilities to be reiterated? As we detail out in this article, there may be need for action on several fronts on the part of listed entities – identification of nodal persons, listing developments that need to be communicated, constituting team for responding to the findings of the auditors in course of their audit other than those that sit in the audit report, formation of sub-groups of TCWG, etc.
Read more →Partly Paid Shares – Whether Doppelganger of Share Warrants?
– Pammy Jaiswal and Saket Kejriwal | corplaw@vinodkothari.com
Background
In recent times, the use of partly-paid shares has seen some traction[1] where several listed companies[2] came up with issuance of partly-paid shares[3]. While the law provides for the issuance of partly-paid securities, it is important to understand how this instrument has not been used merely as a capital-structuring tool, but arguably, as a regulatory workaround. An analogy may be drawn to a situation where a customer is allowed to purchase a valuable by paying a token money today and pay the full consideration after a period of say 1-2 years at the same price which prevailed at the time of payment of token money. Specifically, promoters and investors appear to be utilizing partly-paid shares as a substitute for share warrants, by paying a minuscule part of the value of shares as a part of application money and the balance payment is allowed to be made at any time in the future, sometimes after an unreasonably long time.
In this article, we argue that the issue of such partly-paid shares is as good as issuing share warrants, However, circumventing the challenges associated with warrants.
Fundamentals of Share Warrants
Ashare warrant is a security issued by a company that grants its holder the right/option to subscribe to equity shares of the company (i.e. Future Equity) at a predetermined price, within a predetermined period, upon the upfront payment of a token amount referred to as the option premium.
Legal Context
A share warrant, being marketable in nature, provides a right in securities, therefore, it is treated as a security under Section 2(h) of the Securities Contracts (Regulation) Act, 1956. Some of the relevant legal provisions would include:
- Sections 42, 62 and other relevant provisions of the Companies Act, 2013; and
- The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
Key Features
- Right to Decide: A share warrant allows an investor to subscribe to the company’s equity shares in the future, typically at a price lower than the anticipated market price at the time of exercise. Conversely, if the market price at the time of exercise falls below the pre‑determined price, the investor may choose not to subscribe, thereby limiting their loss to the option premium paid (i.e., the upfront cost), rather than incurring the full loss arising from the difference between the initial/subscription value and the reduced market price.
- Option Premium: The upfront amount paid for obtaining this right is called the option premium i.e. if the current market value of shares is Rs.100, then the issuer may issue equity shares immediately at Rs.100, or Issue a share warrant where the investor pays Rs. 10 upfront for the right to subscribe the equity at Rs. 100 in the future. If, at the time of exercise, the market price of the share has risen to Rs. 120, the investor benefits from locking the price at Rs. 100, making the Rs. 10 upfront cost worthwhile. Conversely, if the market price falls to Rs. 50, the investor may choose not to exercise the warrant, limiting the loss to Rs. 10 i.e. option premium. This forms a part of the net worth of the company. For details on option pricing, may refer to our resource on Option Pricing Model.
- Forfeiture: If the warrant holder chooses not to exercise the right, the upfront option premium is forfeited.
Pricing
The value of option premium is generally determined by Black Scholes Model, Binomial Options Pricing Model or Monte Carlo Simulation Method. The most appropriate method for calculation of option premium, in the context of companies using warrants as a regulatory workaround, is the Simulation Method.
One of the key features of share warrants is that the longer the life of the option, there is a higher probability of its price being high. In accordance with the above models, issuing share warrants for an extended period can raise the option premium to a point where it becomes undesirable. Therefore, it is recommended that the life of a warrant should be just and reasonable, and that it should not be used as a substitute for long‑term convertible instruments such as OCDs, CCDs, CCPS, or other similar securities.
Difference between warrants and partly-paid up shares
While both partly‑paid shares and warrants involve an upfront payment towards a future right in equity shares, they differ significantly on the following points:
| Basis of Difference | Partly-Paid Shares | Share Warrants |
| Right and Obligation | Holder is obligated to pay the remaining call money when demanded by the company. Failure to pay will lead to forfeiture of the subscription and call money received by the company. | Holder has a right, but not an obligation, to subscribe to equity shares at a future date. |
| Nature of Investment | These are equity shares issued with part of the value paid upfront, making the holder a shareholder of the company. | These are options issued for a premium, entitling the holder to subscribe for equity shares in the future. |
| Valuation | Shares are subscribed at fair value computed as on the date of making the first subscription/ call money | Shares are subscribed at current fair value on a future date along with payment of option premium |
| Shareholder Rights | Partly-paid equity shareholders enjoy rights proportionate to their paid-up amount. | No rights until conversion. |
Why are partly-paid shares doppelgangers ?
Partly-paid shares in its usual nature when used for capital needs in tranches serves the permitted purpose for this concept was introduced, however, this benefit becomes a governance concern when it is used as an alternative to share warrants and as evident from the table above, the two differ in various aspects. The primary reason for this mirroring lies in valuation. In the case of share warrants issued with a longer tenor, the cost of the warrant, representing the right to subscribe to future equity, tends to be higher when calculated using fair value methods, making this option impractical. As an alternative, many companies have opted to issue partly-paid shares, allowing an investor to pay only a minimal upfront amount (similar to the option premium in the case of a warrant) as part of the application money and reserving the right with the investor to infuse the remaining funds for a longer period like 5-10 years which would not be possible in case of warrants as the premium will increase drastically, if calculated as per fair value methods.
Token money to secure allotment of shares
It is imperative to note that in case of share warrants, the price paid upfront is the option premium which is basically the price paid to get the equity at the current value at the future date as against in case of partly-paid shares, where the investor becomes a shareholder on the first payment date by even paying a nominal part amount reflecting the fair value (consisting of part face value and proportionate premium) as on the date of making such first payment. The catch lies in the fact that there is no legal prescription on the maximum time within which a company needs to make the final call on such partly-paid shares (except in case of IPOs) which in case of warrants runs up to 18 months for listed securities as well as size of the calls which in the case of listed companies requires at least 25% of the consideration amount calculated as per the formula for exercise price[4] with reference date being the record date shall be received at the time of option premium.
One may argue that, given the fundamental difference between the two instruments is that one comes with a right (warrants) and the other with the security (partly-paid shares), they can not be used as substitutes as in case of partly-paid shares the right to call money lies with the Board and the investor is obligated to pay on demand, failing which shares may be forfeited, resulting in the loss of upfront amount paid.
On the other hand, a share warrant gives a right to the investor to decide when, or even if, to make the payment. If the investor chooses not to exercise the option, the upfront money paid is still forfeited, with the key difference being that the loss occurs at the investor’s discretion.
The above argument is valid theoretically. However, in practice, this mirroring is frequently used by start‑ups, which are generally incorporated as private companies. In such cases, although the ‘right to call money’ rests with the Board of Directors, the Board itself typically comprises the promoters i.e. the very investors who subscribe to these mirrored partly-paid shares or in the case of external investors/subscribers, their appointed representatives form an integral part of the Board. As a result, the obligation on the subscriber to pay the balance can, in reality, be viewed more as a right, given that it is exercised by a Board largely aligned with the interests of the investors themselves.
Additionally, partly-paid shares provide several benefits to the investor, like proprietary rights, chances to book profits in case of transfer, etc.We have discussed the same below:
Proprietary interest of partly-paid shares
Partly-paid shares are not merely rights in equity shares but allotment of the shares itself. Once an investor pays the subscription money/ first call, the shares are allotted to the investor who becomes a shareholder immediately and gets ownership rights from day one. Having said that, while the benefits arising out of such ownership is proportional to the amount paid up on the shares, it still dilutes the stake of the other investors who hold fully paid up shares.
The investor’s economic risk is lower compared to a fully paid-up shareholder since only part of the share price has been paid, the investor’s capital at risk is limited to the amount actually contributed, while the ownership position in the company already stands created.
Chance to book profits by transfer of partly-paid shares
If an investor who has paid only a nominal amount intends to sell such shares for reasons like liquidity or apprehension of the investee not doing well for some reason, he stands a chance to make profits on the part payment where the fair value of such shares have appreciated at the time of such transfer. A purchaser can acquire ownership interest by paying only the fair value of the amount paid-up, while the remaining payment is effectively locked in at the historical fair value. This allows the investor to benefit from future upside without proportionately funding the company at the prevailing fair value for the unpaid portion, which remains priced at the value as on the date of issuance.
Imagine a situation where Mr. A invests in the partly-paid up equity shares of XYZ Ltd. The fair value of the equity shares is say INR 150 (face value INR 10) where Mr. A invests only INR 30 as paid up amount. Thereafter he decides to sell these partly-paid shares to another investor after 2 years by which time the balance amount is still uncalled. The transfer of these partly-paid shares would be done at a fair value where lets assume the value of the shares have appreciated and as a consideration, Mr. A receives INR 80 as the sale consideration and also passes on the legacy of holding partly-paid shares to the buyer.
However, this issue does not arise in listed companies, where market mechanisms ensure fair price discovery.
An Ideal partly-paid share
Situation where a partly-paid share shall not be considered as a share warrant
In our view, partly‑paid shares should be supported by a concrete plan or blueprint specifying when the call money is expected to be raised along with its purpose. This includes:
- A defined timeline for making the call on unpaid money;
- A specific purpose for which the call money will be used; and
- An upfront subscription amount that is significant and reflects commitment, rather than being a token.
Even if an exact date cannot be determined, it is advisable to link the call to milestones/events ,such as regulatory approvals, project launches, or specific capital needs, rather than leaving it open-ended. This approach distinguishes a legitimate capital-raising intent from doppelganger design of warrants.
Situation where a partly-paid share shall be considered as a share warrant
A partly-paid share may raise regulatory concerns when above conditions do not exist. This includes situations where the initial application amount is nominal, resulting in minuscule capital infusion. Additionally, if the call structure is vague and lacks a defined timeline or commercial justification, it creates ambiguity around the company’s intention to actually raise the remaining capital. The concern is further amplified when the Board of Directors, which holds the discretion to make the call on these partly-paid shares, is influenced or controlled by the very investors who subscribed to these shares. In such scenarios, the obligation to pay the balance amount may become just theoretical.
Conclusion
The intention behind partly-paid shares is to raise capital while allowing the issuer to secure future source of funding, However, when a minuscule amount is paid at the time of subscription of partly-paid shares and the remaining calls are deferred for a long period without any definite /concrete plan, this raises concern as sighted above and from a valuation perspective may not be seen as a partly-paid shares.
[4] Regulation 67 of SEBI ICDR, 2018
Read more:
Share warrants under cloud – are companies not allowed to issue share warrants?
RPTs: Understanding the exact nature of Omnibus Approval
– Pammy Jaiswal | corplaw@vinodkothari.com
Click here to watch the related video.
Our other resources:
RBI norms on intra-group exposures amended
– Payal Agarwal | payal@vinodkothari.com
– Aligns intra group exposure norms with Large Exposure Framework; junks a 2016 framework for “large borrowers”
On 4th December, 2025, less than a week after the massive consolidation exercise of RBI regulations, the RBI carried out amendments vide Reserve Bank of India (Commercial Banks – Concentration Risk Management) Amendment Directions, 2025, thus amending the recently consolidated Reserve Bank of India (Commercial Banks – Concentration Risk Management) Directions, 2025.
Applicability of the Amendment Directions
- 1st January, 2026 – for Repeal of provisions on Enhancing Credit Supply for Large Borrowers through Market Mechanism.
- 1st April, 2026 – for other amendments
- Banks may decide to implement such amendments from an earlier date
- In case of any breach in exposure limits pursuant to the Amendment Directions, the exposures to be brought down within 6 months from the date of issuance of the Amendment Directions, i.e., 3rd June, 2026.
Intent behind the Amendments and Key changes
- Repeal of requirements pertaining to credit supply to Large Borrowers through Market Mechanism (draft Circular proposing such repeal can be accessed here)
- This is based on the Statement on Developmental and Regulatory Policies dated 1st October, 2025, wherein the extant guidelines pertaining to Large Borrowers were proposed to be withdrawn, in view of the reduced share of credit from the banking system to such large borrowers, and existence of LEF to address the concentration risks at an individual bank level.
- The repeal relates to a 2016 Notification (forming part of Chapter IV of the existing Concentration Risk Management Directions), whereby certain “specified borrowers” were identified, meaning those entities which had borrowed, on an aggregate from the banking system, including by way of private placed debt instruments, in excess of Rs 10000 crores.
- There is a notable difference between LEF and the “specified borrowers” as covered by the 2016 Notification – the latter relates to large borrowers on an aggregate basis, whereas LEF still looks at the size of exposure relative to the Tier 1 capital of a single lender. However, the “specified borrower” regime is said to have lost its relevance.
- Alignment of requirements w.r.t. Intra-group transactions and exposures (ITEs) with the Large Exposure Framework (LEF) [see press release on the proposed amendments here]
- Computation of exposure under ITEs to be made consistent with that under LEF
- Linking exposure thresholds for ITEs with Tier 1 capital instead of existing paid-up capital and reserves.
- Clarifications w.r.t. prudential treatment of exposures of foreign bank branches operating in India to their group entities
A track change version of the Reserve Bank of India (Commercial Banks – Concentration Risk Management) Directions, 2025, as amended vide the present Amendment Directions can be accessed here.
Refer to our other resources here:
