Businesses
Business Financing: Bank or Partners, and What Applies to Interest
Published · 8 min read · NS Accounting & Tax Office
Written by the NSTAX team of accountants and tax advisers
Most small companies are financed in their first years with a combination of a bank loan and money put in by the partners themselves, often without having clarified what kind of act this money is for tax purposes. The difference between a loan, a capital increase and an informal "help" from the partner is substantial: it determines whether interest is deductible, who pays tax and what the auditor will ask for. In this article, NSTAX explains how interest is treated for tax purposes in each case and what is needed to protect the business.
The Three Main Sources of Financing
A company can be financed in three main ways:
- Bank loan: the company borrows from a financial institution and pays interest
- Partner loan: the partner lends money to the company, with or without interest, and the company assumes an obligation to repay it
- Share capital increase: the partner contributes money as capital, which is not repaid as a loan and carries no interest
Each option has different consequences for the books, the taxation and the flexibility of the company, so the decision must be taken consciously and documented in writing.
Is Interest Deductible as an Expense?
Interest paid by the company is an expense that reduces taxable profit, provided it meets the general conditions for the deduction of business expenses: it is incurred in the interest of the business and not for the personal needs of the entrepreneur, it corresponds to a real transaction and it has been recorded in the books. In the event of an audit, the tax authority examines both the business purpose of the loan and whether the interest rate is reasonable, that is consistent with market terms.
The Interest Limitation Rule
The Income Tax Code provides a rule limiting the deduction of interest: the exceeding borrowing costs, that is the net cost of interest above interest income, are deductible in the year they arise only up to 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA). At the same time, the law grants the right to fully deduct exceeding borrowing costs up to the amount of €3,000,000. In practice, this means that the EBITDA rule usually does not affect small and medium-sized companies, whose borrowing costs are far below this threshold. This rule, however, does not abolish the examination of the business purpose and the interest rate.
Loan from a Partner to the Company
When a partner lends money to their IKE, the company assumes an obligation to repay it and, where agreed, to pay interest. This interest is income of the partner and is taxed at a rate of 15%. The withholding and remittance of the tax is carried out by the company itself, which also issues the relevant interest certificate. If no interest is provided for, caution is needed: between related persons, the tax authority may examine whether the transaction was made on market terms.
Loan from the Company to the Partner: The Trap of the "Interest-Free" Benefit
The reverse direction, where the company lends money to its partner, is more sensitive. If the loan is interest-free or carries an interest rate lower than the market rate, the difference may be considered a taxable benefit of the partner, calculated on the basis of a reference interest rate. Unlike interest paid by the company, in this case no withholding tax is applied in the same way, and the benefit must be correctly reflected in the company’s records. Because the consequences depend on the partner’s status and the terms of the loan, this case always requires an individual assessment.
Two Calculation Examples
Example 1: Loan from a partner to the company
- A partner lends their IKE €50,000 at an interest rate of 4% per year.
- Annual interest: €50,000 × 4% = €2,000
- Withholding tax of 15%: €2,000 × 15% = €300
- Net amount received by the partner: €2,000 − €300 = €1,700
- The company records the €2,000 of interest as an expense, which reduces its taxable profit and, at a 22% rate, its tax by €2,000 × 22% = €440, provided the deduction conditions are met
Example 2: Loan from the company to the partner
- The IKE lends the partner €50,000. Suppose the market reference interest rate is 6%.
- If the loan is interest-free, the partner’s annual benefit is calculated at €50,000 × 6% = €3,000
- If the partner pays an interest rate of 4% (€2,000 per year), the benefit is limited to €3,000 − €2,000 = €1,000
The interest rates and amounts are hypothetical and are used only to show the logic of the calculation.
What Every Loan Always Requires
- A written agreement, with the amount, interest rate, repayment period and signatures of the parties.
- Disbursement and repayment through a bank account, so that there is a trail of every movement.
- Correct recording in the books as a liability to the partner or the bank, and not as income.
- Withholding and remittance of 15% tax on interest paid to the partner, with the issue of a certificate.
- Checking whether the agreement entails fees or stamp duty, which depend on its type, before signing.
Loan or Capital Increase: What Suits When
A loan suits when:
- The financing is temporary and the partner wants to claim it back
- You want flexibility in repayment, without amending the articles of association
- The interest serves a business purpose and the interest rate is reasonable
A capital increase suits when:
- The company needs a permanent strengthening of its equity, for example for bank financing or large investments
- You want neither an interest burden nor a repayment obligation
- You are planning the entry of a new partner or investor
If the issue is withdrawing profits from the partners, see how dividend distribution in an IKE works. For financing equipment or a business vehicle, also consider business leasing as an alternative.
The Most Common Mistakes
- Transferring money between the partner and the company without a written agreement, so that it cannot be proven whether it is a loan or capital
- Paying interest to the partner without withholding tax and without a certificate
- Interest-free loans from the company to the partner, without considering the possible taxable benefit
- Recording the partner’s personal expenses as business expenses through a "loan"
- Transferring cash instead of a bank movement, resulting in an inability to provide evidence
- Assuming that the EBITDA rule never needs checking, while the business purpose and the interest rate are always examined
5 Practical Tips
- Always sign a written loan agreement before the money is transferred.
- Choose an interest rate that is realistic in relation to the market and can be justified.
- Make sure disbursements and repayments are made exclusively by bank movement.
- Inform your accountant before every loan to or from a partner, so that the recording and withholding are done correctly.
- Assess whether your need is temporary (loan) or permanent (capital increase) before choosing the form.
Frequently Asked Questions
Can a partner lend to their IKE and receive interest?
Is the interest on a bank loan deductible?
Does the 30% of EBITDA rule apply to a small IKE?
Can the company lend to its partner interest-free?
Is a written agreement required for a partner loan?
Planning a Loan or Financing for Your Company?
NSTAX, an accounting and tax advisory firm in Athens, helps you choose the right form of financing, drafts or reviews the loan agreement and handles the withholding and interest certificates. Contact us before the money is transferred.
Explore NSTAX business services too.
The rules on the taxation of interest and borrowing are based on the current framework and may be amended or differ case by case. The examples and interest rates are indicative. For an accurate picture of your own business, contact us. This article does not constitute legal advice.