Loan from the Owner to the Company: Secrets, Pitfalls, and Restrictions - AMS Group

Loan from the Owner to the Company: Secrets, Pitfalls, and Restrictions

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Conducting business in Estonia opens numerous opportunities for company owners to finance their companies. One such opportunity is issuing a loan to their own company. However, it is essential to remember that the loan process is regulated by law and has its own specificities. In this article, we will explore how an owner can issue a loan to their company and why the reverse process – receiving a loan from their company – is impossible under Estonian law.

Issuing a Loan from the Owner to the Company

For an owner to issue a loan to their company, certain rules and recommendations must be followed. It is important to ensure that all transactions are correctly documented and comply with legal requirements to avoid legal and tax issues in the future.

Drafting a Loan Agreement

  • The loan agreement between the owner and their company must be in written form and contain all necessary conditions, including the loan amount, term (if applicable), interest rate (if applicable), and repayment schedule (if applicable). In other words, a loan from the owner to the company can be indefinite and interest-free.
  • If you decide to issue a loan to the company with interest and for a specific term, it is important that the loan conditions are market-based, meaning the interest rate and other conditions should not significantly differ from those prevailing in the market for similar transactions.
  • The agreement can be drafted in a free form or using a template from Nola Accounting.

How to Assess Market Conditions

  1. Request proposals from commercial banks for the amount you intend to loan to the company. Calculate the average interest rate from all proposals. Keep the proposals in your personal archive.
  2. Search for "Ärilaenude võrdlemine" (Business loan comparison) in any search engine. Review websites that offer credit comparison for businesses and calculate the average interest rate. Ensure you save the information you used to calculate the average rate, at least in the form of screenshots.

Tax Implications

  • Interest paid on the loan to the owner can be considered as a company expense, reducing the company's taxable income. However, it is crucial to ensure that the interest rate is market-based, otherwise, tax authorities may dispute these expenses.
  • The owner must report the received interest as income in their personal tax return and pay income tax on it if they are not a tax resident of Estonia. A non-resident of Estonia needs to independently determine how to declare such income in their country of tax residency.
  • If the owner is a tax resident of Estonia, the company is obligated to withhold income tax on the interest and declare it in the TSD declaration with each interest payment. NB! If you are on the Nola Start or Nola 1.0 plan, paying interest will automatically move you to the Nola 2.0 plan because your company will be required to submit the TSD declaration.

Why the Company Cannot Issue a Loan to the Owner

According to § 159 of the Estonian Commercial Code (Äriseadustik), companies are prohibited from issuing loans to their board members and owners. This prohibition aims to prevent conflicts of interest and protect the interests of the company and its creditors.

  • A company cannot issue loans to its board members, managers, and owners because such actions can lead to abuse of position and harm the company and its creditors.
  • Violation of this rule can result in legal liability for board members and possible fines for the company.

Reference to the Law: Estonian Commercial Code § 159

Practical Examples

Issuing a Loan:

For example, an owner can issue a loan to their company in the amount of €50,000 at an annual interest rate of 5% for a term of 3 years. Such a loan agreement must be in written form and included in the company's accounting records. Interest on the loan must be accrued and paid according to the agreement.

Violation of the Loan Issuance Prohibition:

If an owner decides to take a loan from their company, it would violate § 159 of the Estonian Commercial Code. For example, if an owner arranges a loan agreement for €20,000 for personal needs, such an agreement would be illegal, and tax authorities could impose fines on the company and demand the funds be returned to the company.

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Issuing a loan to your company can be a useful tool for financing its activities. However, the owner must strictly adhere to legal norms to avoid legal and tax issues.

It is important to remember that receiving a loan from your own company is impossible under Estonian law, which serves to protect the interests of the company and its creditors. Following all rules and recommendations allows you to conduct business legally and efficiently, minimizing risks and ensuring the stable development of the company.

This approach to loan issues and compliance with legislation will help you effectively manage your company's finances and avoid potential problems in the future.