Testing for related-party transactions routed through an unrelated intermediary means tracing the full flow of goods, services and cash around a transaction that on paper involves only unrelated counterparties, specifically looking for an intermediary that exists mainly to break the direct link between two parties that are in fact related — a structure typically identifiable from the intermediary's thin margin, its lack of independent business substance, and the near-simultaneous timing of the back-to-back legs on either side of it.
Why this is a pattern-recognition exercise, not a document check
No single contract will say the intermediary exists to disguise a related-party relationship. The evidence is in the pattern: the intermediary buys from party A and sells to party B at nearly the same price, on nearly the same day, with no inventory risk, no value added, and sometimes no employees or physical operations capable of actually trading in the goods concerned. Finding this requires looking at the transaction cycle as a whole rather than testing each leg independently, which is how it most often goes unnoticed.
The testing sequence
- 01Start from the related-party identification working paper and the undisclosed related-party screening already performedThis procedure is most useful when applied to counterparties that have already shown some indicator of a hidden relationship — a common address, a common director's family connection, or a vendor that appeared suddenly with a large transaction volume.
- 02Map the full transaction chain for high-value or unusual counterpartiesFor a selected vendor or customer, trace the goods or service backward and forward through the chain — who supplied the intermediary, and who the intermediary supplied — rather than looking at the entity's own direct counterparty in isolation.
- 03Test the intermediary's margin and the timing between its purchase and its onward saleA consistent, thin margin on a back-to-back transaction, combined with a purchase and onward sale dated within days or even hours of each other, is the signature pattern of a pass-through structure rather than genuine independent trading activity.
- 04Test the intermediary's own substancePublicly available filings, GST registration details, and any information in the entity's own vendor or customer master file — an intermediary with no employees, no warehousing, and a registered address matching a residential flat or a shared office is a strong indicator it exists on paper only.
- 05Look for a common thread connecting the entity and the ultimate counterparty beyond the intermediaryA shared director, a shared auditor, a shared registered address at some point in corporate history, overlapping promoter family members, or financing flows between the ultimate counterparty and the entity's own promoters outside the trading relationship.
- 06Test whether the pricing through the chain reflects an arm's length outcome for the entityCompare the price the entity actually paid or received, after the intermediary's margin, to prices for the same goods or services available directly in the market — a consistent premium or discount that benefits the ultimate related counterparty at the entity's expense is the economic substance the structure may be designed to achieve.
- 07Test the cash flow around the transaction, not just the invoice trailPayment terms, actual payment dates, and any netting or set-off arrangement between the entity and the intermediary, or between the intermediary and the ultimate counterparty, can reveal a financing relationship dressed up as a trading one.
- 08Escalate the finding and reconsider the related-party disclosure as a wholeWhere the evidence supports a round-trip structure, the transaction should be reassessed as a related-party transaction for disclosure and approval purposes — including testing whether the original approval process for the apparently unrelated transaction would have been different had the relationship been known — and the broader population of transactions with the same intermediary should be reviewed, not just the one transaction tested.
| Indicator | What it suggests |
|---|---|
| Thin, consistent margin on back-to-back legs | Intermediary is a pass-through, not an independent trading party |
| Purchase and onward sale dated within days of each other | No genuine inventory holding or independent trading risk |
| No employees, warehousing or physical operations at the intermediary | Lack of substance consistent with a structuring entity |
| Common director, address or promoter family link beyond the intermediary | Evidence of an actual, undisclosed relationship |
| Pricing that consistently favours the ultimate counterparty | Economic substance of a related-party benefit, achieved indirectly |
Treat a sudden, high-volume new vendor or customer with no prior trading history and an unusually thin, stable margin as a specific fraud risk indicator in its own right, independent of whether a related-party link is ultimately proven — the pattern alone is reason enough to broaden the testing before accepting the relationship as purely commercial.
How we think about this
Mapping the transaction chain, comparing margins and dates, and checking public filings for an intermediary's substance are all evidence-gathering steps that can and should be done systematically across the full population of unusual counterparties, not just the one flagged by chance. Concluding that a pattern actually amounts to a disguised related-party relationship, rather than an unusually efficient but genuine trading arrangement, is a judgement the auditor has to reach and be prepared to defend, not a box a checklist can tick.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Related parties & disclosuresUndisclosed related parties: red flags to test forThe counterparties that most need scrutiny are the ones nobody flagged as related. Here is what actually surfaces them.
- Related parties & disclosuresIdentifying related parties: the audit starting pointA client declaration is a starting point for the related-party list, not evidence of it. How to build and cross-check the list independently.
- Purchase & AP auditVendor master data governance audit: duplicates, stale records, and approvalsA duplicate vendor record isn't a data-quality curiosity — it's how duplicate payments and fictitious vendors both get past controls that check the invoice but never check the master.
- Internal audit & IFCFraud risk assessment: building it into the audit planThe fraud triangle applied practically rather than as theory, why management override is a presumed risk on every engagement, and what journal entry testing is actually looking for.
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