Lending or borrowing money from a family member or friend is a common practice, but it's rarely formalized with the care it needs, which can create problems both in the personal relationship and with the tax authorities if it isn't done properly.
It's completely legal, but worth formalizing
There's no legal obstacle to two individuals agreeing on a loan between themselves, with or without interest. However, the absence of a formal contract can create serious problems if a later disagreement arises over the amount, the term, or even whether the money handed over was a loan or a gift.
Why you should put the loan in writing
A loan agreement between individuals, even a simple one, should at minimum record: the amount lent, the repayment term, whether interest was agreed and how much, and the method of payment. This document not only protects both parties in case of a dispute, it's also the proof you'll need to show the tax authorities that it really was a loan, not a disguised gift.
The tax risk of not formalizing it: the presumption of a gift
If you hand over a significant amount of money to another person with no documentation proving it's a loan, the tax authorities can presume it's a gift, subject to the Inheritance and Gift Tax, which can carry a considerably higher tax cost than the lack of taxation on a well-documented loan that's properly repaid.
Agreed interest is also taxable
If the loan between individuals includes interest, the lender must declare that interest received as investment income on their income tax return, just as if it came from a bank deposit, regardless of whether the tax authorities are directly aware of the transaction through other channels.
An interest-free loan can also have tax consequences
An interest-free loan between individuals with no family relationship could, in certain circumstances, be interpreted as a transaction that should have generated income (interest) at market value, with the corresponding tax implications, although in practice this issue is usually assessed based on the specific circumstances of each case.
The obligation to declare large loans
Loans between individuals above certain thresholds also carry specific reporting obligations to the tax authorities (related to the Transfer Tax, although loans between individuals are usually exempt if certain formal requirements are met), so it's worth getting properly informed before formalizing transactions of a significant amount.
Calculate fair terms for the loan
If you're going to formalize an interest-bearing loan between individuals, our personal loan calculator can help you work out a reasonable payment and total cost, as a reference for agreeing on clear terms between both parties.