Loans between a Shareholder and a Company and the Obligation to Charge Interest

If a company finds itself in a more challenging financial situation due to various factors, there are many ways to gradually address it. One of them is a loan provided by one of the company’s shareholders for the benefit of the company. Or the opposite situation may need to be resolved, namely when the company lends money to one of its shareholders. Different aspects of the obligation to charge interest on the loan also stem from this.

Loan or Credit?

Loan

With the "new" Civil Code effective since 2014, the commonly used term loan has been replaced by the term loan for consumption. Loans for consumption are governed by Sections 2390 - 2394 of the new Civil Code. The basic provision in Section 2390 states that if the lender provides the borrower with a fungible item so that the borrower may use it at their discretion and return an item of the same kind after a certain period, a loan agreement is created. Not only money but also other items may be loaned. In the case of a loan for consumption, interest may or may not be agreed upon. A loan agreement may also be oral.

Credit

Credit agreements are governed by Sections 2395 - 2400 of the Civil Code. The basic provision in Section 2395 states that under a credit agreement, the creditor undertakes to provide the debtor, upon request and for their benefit, with monetary funds up to a certain amount, and the debtor undertakes to repay the funds and pay interest. 

Therefore, agreeing on interest is an essential part of a credit agreement. Unlike the previous regulation under the Commercial Code, the Civil Code does not prescribe a specific form for a credit agreement, so it may also be oral. However, the law (the Consumer Credit Act) requires a written agreement where consumer credit is concerned. Only monetary funds may be the subject of credit, not other items.

If the agreement directly specifies a particular use of the borrowed financial resources within the credit arrangement, the lender may restrict the provision of funds solely to fulfilling those defined purposes. In both cases, the agreement may be concluded by both entrepreneurs and non-entrepreneurs.

Differences Between Credit and Loan

Shareholder Loan to the Company

In cases where a shareholder lends money to the company, the interest rate should generally range between 0 and the market interest rate. This follows from Section 23(7) of the Income Taxes Act, which provides an exception for interest rates lower than usual.

If the interest is higher, the company may not claim it as a tax-deductible expense, or it may not be recognized. If the value of the loan exceeds four times the company’s equity, an issue arises regarding tax deductibility due to the thin capitalization test under Section 25(1)(w) of the Income Taxes Act. 

Interest becomes a tax-deductible expense for the company only once it has been paid. Section 24(2)(zi) of the Income Taxes Act adds a payment condition for tax deductibility. However, this applies only if the creditor is an individual who does not keep accounting records.

For the shareholder, i.e. the creditor, the received interest becomes taxable income, and the company does not withhold withholding tax upon payment. If the shareholder provides an interest-free loan to their company, no tax is imposed and no tax consequences arise. 

The most common legal basis is a shareholder loan agreement for monetary funds. Such an agreement becomes valid upon delivery and acceptance of the loaned item.

In the case of lower-than-market interest, the debtor is not obliged to recognize the difference between the agreed and market interest as income, even though some economic benefit from the free use of external funds remains within the company. If a shareholder provides credit to the company, unlike a loan, the interest must be agreed in advance.

Another option besides a loan is the provision of an additional contribution outside the registered capital. Such a contribution strengthens the company’s equity and forms part of its own resources. It is used, among other things, where the thin capitalization test might otherwise not be met successfully.

Accounting for a Shareholder Loan to the Company

When the Company Lends to a Shareholder

In this case, the reduction of the company’s cash must not in any way restrict its operations or its ability to meet obligations towards existing clients. Interest constitutes taxable income for the company even if it has not yet been paid by the shareholder. This agreement should be in writing and include a verified signature. No exception applies, and the interest should be agreed at the market rate.

If interest is not agreed at the market rate, the tax administrator could, under certain circumstances, increase the tax base by the difference between the agreed and market interest. In the case of credit between the company as creditor and the shareholder as debtor, the same principles described above apply.

If a shareholder of a limited liability company is also its managing director, conflict-of-interest rules under the Business Corporations Act, namely Section 54 and following, come into play. If the managing director/shareholder wishes to conclude a loan agreement with their company, they are obliged to inform the general meeting (or supervisory board, if applicable). The general meeting does not need to actively approve the loan for it to be valid, but it has the right to prohibit the conclusion of such an agreement if it would not be in the company’s interest.

Accounting for a Loan from the Company to a Shareholder

How to Determine the Interest Rate?

A common question is how to determine the usual price of money. This may be defined as the interest rate that would be agreed under similar conditions in ordinary business relations between two independent parties. In practice, this means obtaining a comparable offer from a bank or another entity for comparison purposes, or incorporating differing conditions into available offers and evaluating their impact on the price, i.e. the interest rate.

A legal entity accounts for interest in the general tax base as revenue, which appears on line 10 of the corporate income tax return.

Sources:

Civil Code - Sections 2390 - 2400
Business Corporations Act Sections 54 and following
Income Taxes Act
JUDr. Karel Marek, CSc.  - Bulletin of Advocacy - On Credit and Loans