Related Party Loans

Related party loans will come under special scrutiny where the borrower is related to the lender. The question is whether there was a genuine intention to create a debt with a reasonable expectation of repayment, and did that intention comport with the economic reality of creating a debtor-creditor relationship? Would a third-party lender have made the loan on similar terms? Related party loans raise the following questions in my mind: how was the loan documented; is there a note with repayment terms; is the debt secured; does the loan provide for interest; has an interest or principal been paid; has there ever been a default and, if so, has the lender taken action to collect on the loan? The proper characterization of a transfer of funds from a related party is determined by several factors that are indicative of bona fide debt of which both the purported lender and the borrower should be aware: evidence of indebtedness (such as an agreement or note); adequate security for the indebtedness; a repayment schedule, a fixed repayment date, or a provision for demanding repayment; business records (including tax returns) reflecting the transaction as a loan; actual payments under the terms of the loan; adequate interest charges; and enforcement of the loan terms. In my opinion, a bona fide debt arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed or determinable sum of money. 

In the absence of direct evidence of intent, the nature of the transaction may be inferred from its objective characteristics. In this case, no loans were documented. Such objective characteristics may include the presence of debt instruments, collateral, interest provisions, repayment schedules or deadlines, book entries recording loan balances or interest payments, actual repayments, and any other attributes indicative of an enforceable obligation to repay the sums advanced. The absence of an unconditional right to demand payment is practically conclusive that an advance represented donations or gifts. The salient fact was the lack of written evidence demonstrating a valid and enforceable obligation to repay. A reasonable person may ascertain the true nature of an asserted loan transaction by measuring the transaction against the "economic reality of the marketplace" to determine whether a third-party lender would extend credit under similar circumstances. If an outside lender would not have loaned funds on the same terms as did an insider, an inference arises that the advance is not a bona fide loan; in other words, would an unrelated outside party have advanced funds under like circumstances?