A related-party transaction is, in the ordinary case, a corporate-governance question: has the right committee approved it, has it been disclosed, is it on arm's length terms. But the same transaction can become the instrument of a financial crime. Where an RPT is a sham — an inflated invoice, a circular flow of funds, a payment to a shell entity — it can generate "proceeds of crime" through an underlying offence of fraud or criminal breach of trust, and once those proceeds are concealed or dressed up as legitimate, the Prevention of Money-Laundering Act 2002 engages. The result is a dual-layer exposure: a governance breach under the Companies Act 2013 and SEBI's listing regulations on one plane, and a money-laundering prosecution driven by the Enforcement Directorate on the other. This piece traces how a governance failure crosses into criminal territory, and the red flags that mark the crossing.
The Governance Layer: What Counts as an RPT and How It Is Controlled
The starting point is definitional breadth. "Related party" under Section 2(76) of the Companies Act 2013 captures directors and their relatives, key managerial personnel, firms and private companies connected to a director or manager, and body corporates within the same holding-subsidiary-associate group. For listed entities, SEBI's Listing Obligations and Disclosure Requirements Regulations 2015 (LODR) widen the net: promoters and promoter-group members are related parties irrespective of shareholding, as are shareholders holding 10% or more equity (a threshold lowered from 20%, effective 1 April 2023). The width is deliberate — it is the first safeguard against structuring a transaction to escape classification.
The definition of the transaction is equally expansive, and this is where the anti-abuse design becomes visible. Section 188 lists the transaction types (sale or supply of goods, dealings in property, leasing, services, appointment to an office or place of profit, underwriting). But SEBI's LODR definition, in Regulation 2(1)(zc), adds a functional test that reaches beyond form:
"A transaction involving a transfer of resources, services, or obligations between a listed entity or any of its subsidiaries on one hand and a related party ... on the other hand; or ... any other person or entity ... the purpose and effect of which is to benefit a related party ... irrespective of whether a price is charged."
This "purpose and effect" test is the doctrinal hinge. It catches transactions that are formally with a third party but are designed to benefit a related party — precisely the structure a sham RPT uses to obscure its true beneficiary. A transaction can therefore be a governed RPT even where a related party's name appears nowhere on the contract.
The control mechanism sits on three tiers. Every non-exempt RPT needs board approval, with the interested director absenting himself from the discussion. For listed companies, all RPTs require prior audit-committee approval under LODR Regulation 23(2), with omnibus approval permitted for recurring transactions. And material RPTs require shareholder approval by special resolution. Materiality for listed entities is set, since 1 April 2022, at transactions exceeding one thousand crore rupees or 10% of annual consolidated turnover, whichever is lower, with a stricter 5% threshold for royalty and brand-usage payments. The one exemption from these controls that matters for the fraud analysis is the arm's-length-and-ordinary-course exemption: a transaction that is genuinely both is relieved of the heightened approval requirements. A sham RPT, by definition, is neither.
The Crossing Point: When an RPT Generates Proceeds of Crime
A breach of Section 188 is, on its own, a governance violation. Section 188(5) makes contravention punishable with imprisonment up to three years or a fine up to one crore rupees, and an unapproved contract that is not ratified within three months becomes voidable at the company's option. That is the ceiling of the governance layer. The crossing into money-laundering law happens only when the RPT involves an underlying criminal act — not a technical approval lapse, but fraud, misrepresentation, criminal breach of trust or embezzlement — that generates proceeds.
The Prevention of Money-Laundering Act does not criminalise wealth as such; it criminalises the handling of "proceeds of crime," which Section 2(1)(u) defines as property derived, directly or indirectly, from a "scheduled offence." Money laundering itself, under Section 3, is any process or activity connected with those proceeds — concealment, possession, acquisition, use, or projecting or claiming them as untainted property. Two features of the offence give it reach. It is a continuing offence: guilt persists for as long as a person enjoys the proceeds through any of those activities, so there is no single moment at which the wrongdoer must be caught. And it is, for trial purposes, an independent offence — but not a free-standing one. In Vijay Madanlal Choudhary v. Union of India (2023) 12 SCC 1, the Supreme Court held that while a money-laundering charge is tried independently and an ECIR may precede or follow the FIR on the predicate offence, the existence of a scheduled offence remains an essential prerequisite for PMLA proceedings. No predicate offence, no proceeds of crime, no money laundering.
That is why the scheduled-offence question is decisive. The PMLA Schedule lists predicate offences across three parts, and the relevant heads for RPT abuse are in Part A: the Indian Penal Code offences of criminal breach of trust and cheating (Sections 405 to 420), and the Companies Act's own fraud offences — Section 447 (fraud) and related provisions on fraudulent conduct in share dealings and false statements. A fraudulent RPT that involves false invoicing, circular transactions or misrepresentation can therefore constitute a Part A scheduled offence, even though the bare RPT-approval violation would be a civil or administrative matter. The memo puts the distinction plainly: the RPT violation must involve an underlying criminal act rather than a mere regulatory breach.
The Mechanism: Three Patterns and Three Stages
The nexus works through a recognisable set of fact patterns. In each, the RPT is the vehicle through which company funds are extracted and then laundered.
Pattern A — Inflated invoicing
A related party invoices the company for goods or services far above fair value — goods worth ten lakh rupees billed at fifty. The company pays; funds move to the related party. The overpayment is a misappropriation of company property, engaging criminal breach of trust (Section 405 IPC), embezzlement, and cheating (Section 420) where stakeholders are deceived — all Part A scheduled offences.
Pattern B — Circular fund flows
The company pays a related party for services; the related party routes the same sum back to the company's promoters as a "loan" or "dividend." There is no economic benefit to the company, but the funds have passed through the related-party entity and are now available for diversion, with the shell accounting for the movement as a legitimate loan. This is criminal breach of trust plus a misrepresentation to shareholders about the true nature of the transaction, with the circularity itself concealing the source of the funds.
Pattern C — Shell-entity payments
The company pays a related shell entity for "consulting" or an "intellectual-property licence." The shell has no employees, minimal infrastructure and dubious credentials; the funds are funnelled onward to promoters' personal or offshore accounts. The payment dresses a diversion as a legitimate business transaction.
Once one of these patterns has generated proceeds, the memo describes the laundering as unfolding in three stages. First, the scheduled offence generates the proceeds of crime. Second, the beneficiary conceals, possesses, acquires assets with, uses, or — most critically for the PMLA — projects the proceeds as untainted property, for instance by showing them in the balance sheet as a legitimate dividend, a loan repayment or a capital infusion. Third, the enforcement machinery engages.
The Enforcement Architecture: ED, SFIO and SEBI in Parallel
What makes the RPT/PMLA nexus formidable is that a single set of facts can trigger three enforcement bodies at once, each pursuing a different aspect of the same conduct.
The Enforcement Directorate drives the money-laundering track. Under Section 5 of the PMLA, the Director (or an authorised officer not below Deputy Director) may, on a recorded reason to believe, provisionally attach property that is the proceeds of crime for up to ninety days, after which the matter goes to the Adjudicating Authority under Section 8 for confirmation or release. The ED also has search and seizure powers under Section 19 and the power of arrest under Section 36. A conviction under Section 4 carries rigorous imprisonment of three to seven years (extendable to ten for narcotics-linked proceeds) and a fine, together with confiscation of the proceeds. Crucially, Section 24 reverses the burden: once proceedings are initiated, the authority or court presumes, unless the contrary is proved, that the proceeds are involved in money laundering — so the accused must establish the legitimate source of the funds, the arm's-length nature of the RPT, its genuine business justification, and that proper approvals were obtained.
The Serious Fraud Investigation Office pursues the corporate-fraud aspect. Established under Section 212 of the Companies Act 2013, the SFIO can be directed to investigate where the Central Government has reason to believe a company's affairs are being conducted fraudulently or prejudicially to the interests of the company, its members or creditors. It can summon witnesses, search and seize records, record statements on oath, and — where authorised — arrest, and it files its report as a charge sheet directly before the Special Court under Section 212(12), bypassing an ordinary magistrate's FIR. Fraudulent RPTs — inflated invoicing, circular flows, shell-entity structures — sit squarely within its remit.
SEBI occupies the governance-enforcement plane for listed entities, policing disclosure, the genuineness of shareholder approval, and compliance with the materiality thresholds. The memo records recent enforcement signalling a stricter posture — an administrative warning to Paytm (One 97 Communications) over RPTs involving Paytm Payments Bank, and action concerning Linde India over an attempt to execute a material RPT despite shareholder opposition, underscoring that shareholder approval cannot be bypassed. Audit-committee members are not insulated: a failure to pre-approve or properly scrutinise an RPT exposes them to personal liability under the directors'-duties provision, Section 166, and to SEBI enforcement.
The division of labour is clean in principle — SFIO on the fraud, ED on the laundering, SEBI on the disclosure and approval breach — and the memo notes a judicial preference for this structured, agency-led investigation over parallel private criminal complaints in complex corporate-fraud cases, to keep findings consistent and reduce misuse of the criminal process.
Two Doctrines That Close Off the Obvious Escapes
Two features of the framework defeat the most obvious ways of structuring around it. The first is the aggregation doctrine. A scheme that fragments a diversion into many sub-threshold RPTs — ten transactions of fifty lakh each, none individually crossing a statutory limit — can be treated, where they form a coordinated scheme, as a single money-laundering transaction of five crore. Fragmentation does not launder the aggregate. The second is the reverse burden under Section 24 already noted: once the ED demonstrates a reasonable belief that proceeds of crime exist — typically through pattern analysis of the RPT flows — it is the accused who must prove legitimacy, not the ED who must prove guilt to the criminal standard on the laundering.
Red Flags: What Signals a Sham RPT
The compliance value of the nexus lies in spotting the transaction before it becomes a prosecution. The memo's red flags for audit committees and auditors are the practical distillation:
- Fragmented transactions — multiple sub-threshold RPTs with the same related party in a year that cumulatively exceed a threshold, suggesting deliberate splitting to avoid approval (and vulnerable to aggregation).
- Circular flows — an RPT outflow immediately matched by an inflow from the same related party, indicating fund movement rather than genuine economic benefit.
- Inflated valuations — payments for goods or services materially above fair value, unsupported by independent valuation.
- Indefinite tenures — RPT contracts with no specified end date, which SEBI's norms prohibit.
- Absence of documentation — missing transfer-pricing studies, arm's-length certificates or auditor justifications.
- Concealed relationships — failure to disclose beneficial ownership or the related-party connection until it is challenged.
Practical Takeaways
- Treat an RPT as a two-plane risk: a governance breach exposes the company to Section 188(5) and SEBI action; a fraudulent RPT that generates and conceals proceeds exposes it, additionally, to PMLA prosecution by the ED and fraud investigation by the SFIO.
- The dividing line is the underlying criminal act. A technical approval lapse stays in the governance layer; false invoicing, circular flows, shell-entity payments or misrepresentation can constitute Part A scheduled offences and cross into money-laundering law.
- Remember that a predicate scheduled offence remains essential to any PMLA case (Vijay Madanlal Choudhary), but that the money-laundering charge is then tried independently and as a continuing offence.
- Build the defence contemporaneously: because Section 24 reverses the burden, retain, at the time of approval, evidence of arm's-length pricing, independent valuation, genuine business rationale and proper board, audit-committee and shareholder approvals.
- Watch the red flags — fragmentation, circularity, inflated valuations, indefinite tenures, missing documentation and undisclosed relationships — and keep records for at least seven years, given the continuing-offence nature of money laundering beyond the five-year PMLA record-keeping minimum.
- Ensure banks and intermediaries in the chain remain alert to suspicious-transaction reporting to FIU-IND where RPT flows show layering, rapid movement or suspicious beneficiaries.
Key Authorities
- Companies Act 2013, Sections 2(76), 188 and 188(5) — definition of related party, the RPT categories and approval regime, and the penalty for contravention. Source
- SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, Regulations 2(1)(zb), 2(1)(zc) and 23 — the expanded related-party and RPT definitions (including the "purpose and effect" test), audit-committee pre-approval, and the material-RPT thresholds (₹1,000 crore or 10% of consolidated turnover). Source
- Prevention of Money-Laundering Act 2002, Sections 2(1)(u) (proceeds of crime), 3 (offence of money laundering), 4 (punishment), 5 and 8 (attachment and adjudication), and 24 (reverse burden). Source
- Prevention of Money-Laundering Act 2002, Schedule, Part A — scheduled predicate offences, including IPC Sections 405-420 (criminal breach of trust, cheating) and Companies Act fraud offences (Section 447 and related). Source
- Vijay Madanlal Choudhary v. Union of India, (2023) 12 SCC 1 — money laundering is independent for trial but a scheduled offence remains a prerequisite for PMLA proceedings.
- Companies Act 2013, Section 212 — Serious Fraud Investigation Office: trigger, powers, and direct filing of the charge sheet before the Special Court in RPT-related corporate fraud. Source
- SEBI enforcement in RPT matters — administrative warning to One 97 Communications (Paytm) and action concerning Linde India, illustrating stricter policing of disclosure and mandatory shareholder approval. Source
This analysis reflects the law as at May 2026. It is published for general information and does not constitute legal advice.