In practice, it is often necessary for legal entities to attract money from individuals. Various structures are used for this - "temporary financial assistance", "gratuitous financial assistance", "temporary contributions of founders". If money is attracted on the basis of repayment and urgency, such transactions are recognized as a loan, regardless of how they are called in the concluded agreement. Is it possible for a legal entity to attract loans from individuals? Can individuals receive remuneration for these loans? What tax consequences do such transactions entail?
In what cases is such a loan applied?
A loan to a legal entity can be provided:
- participant(s) of a legal entity;
- director or other employee;
- third party.
In accordance with paragraph 1 of Article 55 of the Law of the Republic of Kazakhstan "On Limited and Additional Liability Partnerships", members of the executive body of an LLP are prohibited from: entering into transactions with the partnership aimed at receiving property benefits from it (including gift, loan, gratuitous use, purchase and sale agreements, etc.) without the consent of the general meeting. Thus, if a loan agreement entails the payment of remuneration to the director of an LLP, then such an agreement must be approved by the general meeting of participants (the sole participant).
The purposes of attracting such a loan may be:
- replenishment of working capital;
- payment for the concluded transaction;
- repayment of existing debt.
Reasons for taking out loans:
- the legal entity itself has no money;
- unwillingness to transfer money to a legal entity on a permanent basis (for example, to increase the authorized capital);
- unwillingness to pay extra taxes (if property is transferred to a legal entity free of charge and without return, the latter will incur taxable income).
Loan with interest payment
Is such an agreement possible?
In accordance with paragraph 3 of Article 715 of the Civil Code, legal entities and citizens are prohibited from attracting money in the form of a loan from citizens as an entrepreneurial activity, and such agreements are recognized as invalid from the moment of their conclusion. This prohibition does not apply to cases where borrowers are banks licensed by an authorized state body to accept deposits, as well as to cases of accepting money in exchange for securities, the issue of which is registered in accordance with the procedure established by law. This norm served as the basis for the existence of a widespread point of view, according to which a legal entity under no circumstances can attract a loan from an individual with the payment of remuneration to the latter. In the past, this position was sometimes taken by tax authorities when providing clarifications.
However, the said ban is intended to protect citizens from fraud and the organization of various "financial pyramids". Attracting money in the form of a loan from citizens in the form of entrepreneurial activity, in other words, means accepting deposits from the population with the payment of remuneration, which relates to banking operations and requires a license.
Currently, the prevailing view is that this restriction applies only to cases of using a loan as a means of carrying out entrepreneurial activity.
In accordance with paragraph 1 of Article 10 of the Civil Code of the Republic of Kazakhstan (General Part), entrepreneurship is an initiative activity of citizens and legal entities, regardless of the form of ownership, aimed at obtaining net income by satisfying the demand for goods (works, services), based on private property (private entrepreneurship) or on the right of economic management of a state enterprise (state entrepreneurship). It follows from this concept that entrepreneurial activity is of a permanent and systematic nature. It follows from this that lending money not for the purposes of entrepreneurial activity, even for a fee, is not prohibited. One-time or episodic borrowing cannot be considered as entrepreneurship and does not entail consequences in the form of recognizing the loan agreement as invalid.
This position is currently supported by tax authorities (see, for example, the Letter of the Tax Department for the city of Almaty of the Ministry of Finance of the Republic of Kazakhstan dated January 14, 2010 No. ND-06.1-11/67-yu).
Tax implications
For a legal entity-borrower
In accordance with paragraph 2 of Article 13 of the Law of the Republic of Kazakhstan "On Accounting and Financial Reporting", income is an increase in economic benefits during the reporting period in the form of an inflow or increase in assets or a decrease in liabilities that lead to an increase in capital other than the increase associated with contributions of persons participating in the capital. If there is an obligation to repay the loan received, the money received is subject to recognition in the borrower's accounting as liabilities, which, in accordance with paragraph 1 of the same Article of the Law, are understood to be existing obligations of an individual entrepreneur or organization arising from past events, the settlement of which will lead to the disposal of resources containing economic benefits. Upon return of the loan item, the liabilities will be reduced by the amount of the return.
Thus, the loan amount subject to return is not recognized as income of the legal entity-borrower, and, accordingly, is not subject to inclusion in the total annual income as gratuitously received property.
For an individual lender
Since the loan agreement provides for the payment of remuneration, the individual lender receives income that must be subject to individual income tax at the source of payment at a rate of 10% (Article 158 of the Tax Code of the Republic of Kazakhstan).
In this case, the legal entity acts as a tax agent.
In this case, depending on whether the lender is an employee of the borrower legal entity, the income will be taxed as:
- employee income (Article 163 of the Tax Code);
- income of an individual under civil law contracts concluded with a tax agent in accordance with the legislation of the Republic of Kazakhstan (Article 168 of the Tax Code).
Loan without remuneration
Is such an agreement possible?
The legislation, including Article 715 of the Civil Code, does not contain any restrictions regarding the conclusion of an agreement on the provision of a loan by an individual to a legal entity without payment of remuneration.
Tax implications
For a legal entity-borrower
By analogy with a loan agreement for compensation, the loan amount subject to repayment is not recognized as income of the legal entity-borrower and, accordingly, is not subject to inclusion in the total annual income.
Currently, tax authorities consider the provision of interest-free financial assistance on a repayable basis as a loan transaction and consider it a gratuitous provision of services.
The arguments given in this regard are as follows.
In accordance with subparagraph 6) of paragraph 2 of Article 231 of the Tax Code, turnover from the sale of works and services means any performance of works or provision of services, including free of charge, as well as any activity for remuneration other than the sale of goods, including the provision of a loan (credit, microcredit). According to subparagraph 16) of paragraph 1 of Article 85 of the Tax Code, all types of income of the taxpayer, including income in the form of property received free of charge, are included in the total annual income. And according to Article 96 of the Tax Code, the value of any property, including works and services, received by the taxpayer free of charge is his income. Unless otherwise provided by the Tax Code, the value of property received free of charge, including works and services, is determined in accordance with international financial reporting standards and the requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting.
Thus, tax authorities include the cost of the service in the form of gratuitous use of the loan in the total annual income of the loan recipient. In this case, the amount of such income should be determined based on the accounting data of the loan recipient in accordance with international financial reporting standards and the requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting.
The procedure for determining the cost of a gratuitously received service for providing a loan is not specifically defined or approved. Currently, taxpayers independently determine for themselves in the accounting policy how this income will be calculated. The taxpayer must include the independently calculated remuneration in their income as the cost of the gratuitously rendered service.
Paragraph 11 of IAS 18 Revenue states that when a contract effectively constitutes a financing transaction, the fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest. The imputed rate of interest is the most accurately determinable of the following:
- (a) the prevailing rate for a similar financial instrument of an issuer with a similar credit rating; or
- (b) the interest rate that discounts the nominal amount of a financial instrument to current prices of goods or services when sold for cash.
The difference between the fair value and the nominal amount of consideration is recognised as interest income in accordance with paragraphs 29–30 of IAS 18 and in accordance with IAS 39. In accordance with paragraph 48A of IAS 39 Financial Instruments: Recognition and Measurement, the best evidence of fair value is quoted prices in an active market. If the market for a financial instrument is not active, an entity establishes fair value using a valuation technique. The objective of using a valuation technique is to estimate what the transaction price would be on the measurement date in an arm’s length exchange between parties motivated by normal business considerations. Valuation techniques include using recent market transactions between knowledgeable, willing parties, when available, comparisons to the current fair value of another substantially identical instrument, discounted cash flow analysis, and option pricing models.
Thus, taxpayers must proceed from the current prices for similar services if they received them for a fee. The cost of the service for providing a loan is the amount of remuneration. In this case, to calculate the cost, it is necessary to take into account not bank interest rates, but rates on loans provided by non-financial organizations. The accountant must justify the application of these rates by collecting and analyzing statistical information on similar loans.
Consequently, the amount of income in the form of material benefit from savings on remuneration for such assistance recognized by a taxpayer who has received a loan or, in other words, gratuitous (interest-free) financial assistance on a repayable basis, in accounting, taking into account the application of IFRS, legislation on accounting and financial reporting, is included in the total annual income of the borrower and is subject to corporate income tax.
For an individual lender
Since the individual who issued the loan does not receive any income in this case, he does not have any tax obligations.