It is well known to many that a loan with a very low interest rate is quickly deemed to be uncommercial. Now, Court in The Hague It was recently ruled that a loan from parents to their son at an interest rate of 9% per annum cannot be classified as a commercial loan either. Despite the fact that no security had been stipulated, the interest rate was too high.
The situation
The case is as follows. The son and his partner live together in a property financed by an annuity mortgage taken out with the son’s parents. The mortgage has a term of 30 years and the interest rate is 9% per annum, with a fixed-rate period of 15 years. No security has been provided.
Donation
Now that the son and his partner qualify as tax partners, they can allocate joint income items between themselves in their income tax returns. This also applies to the balance of the additional tax liability and the interest on the mortgage on their own home.
In their 2015 income tax returns, both the husband and the wife claim a portion of the interest as a deduction. When issuing the 2015 income tax assessment, the tax inspector adjusted part of the interest. In his view, an interest rate of 4.5% qualifies as commercial and in line with market conditions. In his view, the excess portion of the interest is not deductible and constitutes a gift from the son to his parents.
Occupation
The son lodged an appeal. He argued that the loan was a business loan, meaning that the interest was fully tax-deductible. However, he failed to substantiate this position. It is stated, for example, that, with a view to providing for the parents’ income, a higher interest rate was preferred over the provision of security. According to the court, it can be concluded from this that the parents do not face a substantial risk that the son will fail to meet his payment obligations. According to the court, the family relationship is the reason why the agreed terms and conditions are attached to the loan. The agreed interest rate of 9% is not commercial.
District Court ruling
According to the Court, in order to determine which interest rate is commercially reasonable, reference must be made to a market-based interest rate on a loan granted under similar terms. In this regard, the Court concludes that, in 2015, for a loan with a 15-year fixed-rate period secured by collateral, an interest rate of 3% is commercially reasonable. As no security has been provided, a mark-up of 1.5% is accepted. The interest is therefore deductible up to an amount of 4.5% of the principal sum.
Gift tax
The court finds that the excess amount of interest constitutes a gift. The son is making a gift to his parents. In this situation, only the general gift tax allowance applies. In 2018, this allowance amounts to just €2,147. Furthermore, the highest rates apply. Based on the 2018 gift tax rates, 30% gift tax is payable on the first €123,248 in the situation described. Anything above this amount is taxed at 40% gift tax. Due to the high rates and low exemption, the non-commercial loan therefore quickly leads to an additional and undesirable financial burden.
Terms and conditions and full documentation
The ruling confirms that it is of the utmost importance that commercial terms and conditions are applied to any loan entered into between family members. Perhaps even more importantly, the agreed terms must also be adequately substantiated.
Are you planning to take out a loan with a (family) relative in the near future, or do you already have loan agreements with (family) relatives? Check carefully whether the agreed terms are commercial in nature and record this in your files. Non-commercial terms may result in the transaction being treated as a gift, as in the case described, which in turn could lead to unwanted taxation.
If you need help or have any questions about loans and the terms and conditions, you can always contact one of our consultants.