Low-interest loans within the family

In practice, loans within the family are common. Interest-free and low-interest loans are a common tool in families where parents want to financially support their children. After all: people want to support the children and a high interest rate emotionally does not fit in. But how does “playing with interest rates” work and what is admissible or wise? We are happy to explain it.

Why Interest Free and Low-Interest Loans?

In the business world, it is unusual to provide interest-free or low-interest loans because this is contrary to the business principle. Within families, however, this is common because parents want to financially support their children. A high interest rate emotionally does not fit in with this. Parents provide substantial amounts as an interest-free loan to help their children start a business, for example. Should the same loan be taken out at the bank, the children would have to pay interest. This raises the question whether there is a taxed donation of the interest that the parents would normally receive.

How Does It Work Right Now?

From 1 January 2010, an interest-free, immediately due and payable cash loan will be taxed with gift tax according to Art. 15 SW 1956. The debtor is deemed to have acquired the usufruct of the loan as a gift. The term “loan” includes all claims expressed in a sum of money by a creditor.

Admissible Interest Rates

The interest rate of interest-free or low-interest loans has been adjusted to a usual level. Currently, an interest rate of 6% (2024) is used as the benchmark. When a loan is granted with a percentage lower than 6%, a tax adjustment will take place with the gift tax until the interest rate is 6%.

Example 1: Immediate Loan

Suppose, father provided an interest-free, immediately due and payable loan to his daughter of €1,000,000 on 1 January 2024. The daughter is deemed to have received the annual usufruct as a donation. This refers to the correction of the interest rate to a percentage of 6%. The donation then amounts to 6% of €1,000,000, which amounts to €60,000.

For example, if the loan was granted on 1 July 2024, the donation will be prorated. In this case, the donation for that year would amount to €30,000.

Example 2: Non-Claimable Loan

If there is no immediately due loan, the above does not apply. In this situation, it is assessed whether there is a donation based on the main rule. There is no annual standard interest rate of 6% here, but it is examined whether the interest rate and other conditions of the money loan have been determined on business grounds.

Suppose, on 1 January 2024, mother provided her daughter with a loan of €400,000 to finance a securities portfolio, with an annual interest rate of 0.5% (annual deficit of 5.5% interest, EUR 22,000).

The loan is only due after 10 years. In this case, in accordance with the Succession Act, the first 5 years must be valued at 0.84% and the second 5 years at 0.62%. So 5 x 84% or €22,000 + 5 x 62% or €22,000 = 160,600. This amount will be over in 2024 gift tax due.

Win-Win Family Loans: The End of a Beneficial Structure?

The win-win loan is the opposite of an interest-free or low-interest loan. Interest is stipulated here, especially in cases where the interest can be deducted by the debtor (the child) for income tax as home interest in box 1. At the same time, the creditors (the parents) maintain an equal capital return in box 3.

How long will this be a “win-win”?

How Does a Win-Win Loan Work?

Children often finance the purchase or renovation of their home with a bank loan, while their parents have an unused amount in a savings account. The savings rate pays less than the interest that the children pay to the bank. In such a case, it may be more convenient for the child to borrow from their own parents. If the parents receive the interest that the child would otherwise pay to the bank, they have a higher return than on the savings account. In addition, the interest paid by the child remains within the family.

Adjustments to the Capital Return Tax (Box 3)

The Supreme Court has stated that the actual return must be taxed, including unrealised changes in value. Please note that for earlier and current periods, the Supreme Court's ruling only means that the levy can be reduced if less return is achieved than the assumed.

This affects the attractiveness of win-win loans in the future. The interest received from the parents may be taxed immediately. The structure may only remain fiscally advantageous if the deduction benefit for the children exceeds the tax on the returns received by the parents. Nevertheless, the advantage is that the money stays within the family instead of going to the bank.

Conclusion

Interest-free and low-interest loans are popular tools within families for financially supporting children and transferring wealth. However, it is important to take into account the tax consequences and to know that a correction to a usual interest rate of 6% can take place. Win-win loans can still be beneficial, depending on the tax benefits for both parents and children.

Whether transferring wealth within the family is beneficial depends a lot on the personal situation. If you would like to discuss the possibilities, please contact us!