What’s Is It?
When is a loan not a loan? When it’s something else – for example, equity.
This is one of those pesky facts and circumstances issues that plague courts, taxpayers, and tax advisers to no end.
On one end of the spectrum, we have a pure debtor-creditor relationship. Very, very simply, a lender has transferred a portion of its funds to a borrower entity for the borrower’s use for a stated period of time (the “term” of the loan). In exchange for the use of the lender’s money (the principal), the borrower agrees to pay the lender a fixed rate of interest; basically, compensation for the time value of money – the longer the term of the loan, the higher the rate charged. At the end of the term, the borrower is required to return the principal to the lender, plus the amount of the accrued but unpaid interest. To secure its right to be paid the principal and interest, the lender may require that the borrower provide collateral for the loan, or it may require that the owners of the borrower entity guarantee the borrower’s obligations under the loan. On the liquidation of the borrower entity, the lender is entitled to receive the unpaid principal and interest owed by the borrower and nothing more. However, the lender is entitled to receive this sum before any amounts may be distributed to the owners of the borrower entity. To the extent any amount remains after payment of the principal and interest, such amounts belong to the borrower’s owners.
Continue Reading Shared Appreciation Interest: Debtor-Creditor or Partners?