If a director lends money to a company without charging interest, will they be subject to personal income tax?

In business management, especially for small and medium-sized enterprises (SMEs), raising capital from the executives themselves is a very common scenario. Many business owners and directors lend money to their companies without interest to support immediate cash flow and reduce the financial burden. However, from the perspective of tax authorities, this supportive transaction carries potential legal risks regarding tax assessment and collection of personal income tax (PIT) from capital investment. This article will analyze the regulations in detail to answer the question: Does a director lending money to their company without interest truly help the company save costs, or will it lead to an unnecessary tax penalty?

The reality of directors lending money to companies without charging interest.

In a volatile market, accessing bank financing can sometimes be difficult due to cumbersome procedures or high collateral requirements. In such cases, the option of the CEO lending money to the company without interest is often preferred. This is understood as a temporary loan between the individual in charge and the legal entity, the business.

From a civil perspective, according to the Civil Code, the agreement on interest rates is entirely based on the voluntary consent of the parties involved. However, in the field of tax administration, this is a specific related-party transaction. Tax authorities often focus on inspecting these loans during the tax settlement period because they show signs of not complying with market rates and may be a form of tax evasion. The biggest question is: When tax authorities conduct an audit, do they have the right to set an interest rate equivalent to the market lending rate to calculate personal income tax for the lender? To answer this, let's delve into the regulations regarding tax assessment cases with MAN – Master Accountant Network.

Cases where personal income tax is assessed when the director lends money to the company without charging interest.

Based on the provisions of Article 14 Decree 126/2020/ND-CP, The tax authorities have the power to determine the amount of tax payable in various situations. Understanding these situations helps businesses identify why a situation where a director lends money to a company without charging interest is subject to strict scrutiny.

Specifically, there are 12 tax assessment cases that businesses need to pay special attention to:

• Tax registration violation: The taxpayer failed to register for tax as required by Article 33 of the Law on Tax Administration.
• Tax declaration violations: Failure to declare taxes or making incomplete, untruthful, or inaccurate tax declarations as prescribed in Article 42 of the Law on Tax Administration.
• Incomplete or missing supplementary documents: Failure to submit supplementary tax documents as requested by the tax authorities, or submitting supplementary tax documents that are incomplete, untruthful, or inaccurate in terms of the basis for calculating the tax payable.
• Accounting errors: Failure to reflect, or incomplete, untruthful, or inaccurate reflection of data in accounting records to determine tax obligations.
• Lack of supporting documents: Failure to present accounting books, invoices, receipts, and other necessary documents related to determining the factors used as a basis for calculating tax within the prescribed time limit.
• Compliance with inspection: Failure to comply with a tax inspection decision within 10 working days from the date the decision is signed (except in cases where a postponement is granted).
• Compliance with inspection: Failure to comply with a tax inspection decision within 15 days from the date the decision is signed (except in cases where a postponement is granted).
• Non-market price transactions: Buying, selling, exchanging, and accounting for the value of goods and services at prices other than the usual market transaction prices. This is a crucial point in the case where the Director lends money to the company without charging interest.
• Using illegal invoices: Purchasing or exchanging goods or services using illegal invoices, or illegally using invoices where the goods or services are genuine.
• Signs of asset concealment: There are indications of absconding or dispersing assets to avoid fulfilling tax obligations.
• Misrepresented transactions: Conducting transactions that do not reflect their true economic nature or actual occurrence, with the aim of reducing tax obligations.
• Violations related to related-party transactions: Failure to comply with regulations regarding the obligation to declare and determine the price of related-party transactions, or failure to provide information as required.

In a situation where a director lends money to a company without charging interest, the most important point to note is that the transaction may not adhere to market prices and may involve related-party transactions.

Why is a director lending money to a company without charging interest considered a related-party transaction?

To determine whether a transaction is subject to tax assessment, it is first necessary to determine whether the parties involved are related. Based on Article 5 of Decree 132/2020/ND-CP, Specific criteria are used to define this relationship and apply them to the case where a director lends money to a company without charging interest.

Define related parties.

According to regulations, related parties are those parties that have a relationship falling under one of the following categories:

• One party is directly or indirectly involved in the management, control, capital contribution, or investment in the other party.
• The parties are directly or indirectly subject to the management, control, capital contribution, or investment of another party.

See details: Forms of related-party transactions.

Criteria for determining eligibility for loans in affiliated relationships.

Decree 132/2020/ND-CP specifically stipulates in Point g, Clause 2, Article 5 that an enterprise is considered to have an affiliated relationship when:

“"Businesses that have transactions involving the transfer or acquisition of at least 25% of owner's capital contributions during the tax period; or borrowing or lending at least 10% of owner's capital contributions at the time of the transaction during the tax period with individuals managing or controlling the business or with individuals in a relationship as stipulated."”

Thus, when considering the situation where the Director lends money to the company without charging interest, we clearly see the interconnectedness through two factors:

• Regarding the subject: The director is the individual who directly manages and controls the business.
• Regarding the transaction value: If this borrowed amount represents 10% or more of the owner's equity, then this is indeed a related-party transaction.

According to the regulations, when a company borrows money from its director, it is understood that the business has a loan transaction with an individual who manages or controls the business. Therefore, this transaction falls within the scope of the law on tax management for businesses with related-party transactions. The legal consequence is that all agreements on interest rates must adhere to the market price principle (Arm's Length).

Determining personal income tax when a director lends money to a company without charging interest.

Once it has been determined that this is a related-party transaction, the agreement on interest rate 0% is considered a non-compliance with market transaction prices. At this point, according to Clause 12, Article 14 of Decree 126/2020/ND-CP, the tax authority has the right to determine the interest rate for that loan.

How to determine taxable income

Specifically, Article 10 of Circular 111/2013/TT-BTC stipulates the basis for calculating tax on income from capital investment as follows:

• Taxable income: This is the taxable income an individual receives from lending capital to organizations or individuals. In cases where an interest rate is assessed, the taxable income is the amount of interest calculated based on the assessed interest rate (usually the commercial bank interest rate at the same time).
• Tax rate: Applied according to the full tax schedule with a tax rate of 5%.

In that case, the tax calculation formula is as follows:

It is noteworthy that even if the Director did not actually receive interest, because this was a related-party transaction and not based on market price, the tax authorities still considered the interest that would have been earned as personal income from capital investment. The Director's act of lending money to the company without interest implicitly creates a potential tax liability that the Director is personally responsible for paying.

Risks and consequences when a director lends money to a company without charging interest during the actual settlement process.

A director lending money to the company without charging interest not only poses a risk to the individual executive but also creates significant problems for the company's accounting and financial systems.

• Tax arrears and late payment penalties: This is the most direct consequence. If the tax authorities inspect and discover that this loan transaction exceeds 10% of equity capital without interest, they will determine the interest rate. The amount of personal income tax (PIT) of 5% will be collected in arrears plus late payment penalties calculated at a rate of 0.03%/day.
• Difficulty in explaining expenses: If a business has bank loans (with interest payments) but also receives a loan from the Director with an interest rate of 0%, the tax authorities may question the purpose of capital use and the reasonableness of the bank interest expense. This could lead to a portion of the bank interest expense being disallowed as a deductible expense when calculating corporate income tax.
• Obligation to declare related-party transactions: Many businesses forget that when a director lends money to a company without interest, the business is required to declare the related-party transaction appendix: related party transaction appendix This must be included with the annual corporate income tax return. Failure to declare or incomplete declaration is one of the serious offenses subject to administrative penalties and serves as a signal for the tax authorities to conduct a post-audit.
• Cash flow risk: Being unexpectedly taxed after 3-5 years of operation can create sudden financial pressure on the CEO, especially with large loans accumulated over many years.

Reference: Instructions for declaring related-party transactions on HTKK.

Optimal advice for businesses

To ensure both financial support for businesses and compliance with legal regulations, while avoiding tax assessments, MAN – Master Accountant Network recommends:

• Controlling the 10% threshold: Accountants need to closely monitor the balance of loans from the Director. If this amount consistently remains below 10% compared to the owner's equity contribution, the risk of forming an affiliated relationship, as stipulated in Point g, Clause 2, Article 5 of Decree 132, should be avoided.
• Consider a low interest rate instead of the 0% rate: Instead of having the Director lend money to the company without interest, there should be an interest rate equal to the bank's deposit rate in the market at the time of the transaction. This proactive approach is key. declaration of related party transactions Paying personal income tax under form 5% on this interest rate demonstrates transparency and compliance, helping businesses avoid being assessed a higher lending interest rate by the tax authorities.
• Complete the legal documentation: All loans must have a loan agreement, minutes of the Board of Members/Board of Directors meeting regarding the mobilization of borrowed capital from the managing individual. Transfer documents should be made through bank accounts to ensure the authenticity of the transaction.
• Complete disclosure of related-party transactions: If it is determined that the 10% threshold has been exceeded, properly submit the related-party transaction appendix as required.

Conclude

In summary, while a director lending money to a company without interest is a flexible and fairly common financial support solution in businesses, it carries significant tax risks if not done correctly according to legal principles and tax regulations. When the loan exceeds the related-party transaction threshold or fails to comply with market pricing principles, the business may be subject to tax assessment, tax arrears, late payment penalties, and additional related declaration obligations.

If your business is involved in complex transactions and it's difficult to identify related-party relationships, or you have concerns about reporting obligations related to these transactions, personal income tax, and the validity of internal loan applications, consultation is recommended. Transfer pricing advisory services Seek support from reputable and experienced professional organizations such as MAN – Master Accountant Network.

Contact MAN – Master Accountant Network For free support and advice!

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Content production by: Mr. Le Hoang Tuyen – Founder and CEO of MAN – Master Accountant Network, CPA Vietnam with over 30 years of experience in accounting, auditing, and financial consulting.