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Some countries entertain corporate income tax rates significantly lower than personal:

  • Ireland: 12.5% vs 20–52%
  • Estonia/Latvia: 0% vs 20%
  • Sweden: 21.4% vs 32–57%
  • Barbados: 5.5% vs 25–38%

Say Bob lives and operates his business through a company in one of those countries. He receives no (or only some nominal) salary/income, but, being the sole shareholder and director, he lends himself money at 0% interest rate. Although he is formally required to pay that back, the company never pursues the repayments (optionally, the loan agreement sets grace periods lasting for decades, or even explicitly up to Bob's death upon which the company will be the first creditor in line to grab his estate).

So, in essence, Bob receives virtually no income to pay tax on, but enjoys living in permanently growing debt to his own company (which pays its corporate income tax, if any, diligently).

What are the possible legal avenues for tax authorities to stop Bob from doing that? How would they overcome the lawfulness of taking loans on whatever terms the lender and borrower agree?

The question is not necessarily about the jurisdictions listed above. As as variation, let's assume Bob actually lives (and is supposed to pay personal income tax) in the US/UK/AU/NZ but still owns a business in a country above and receives loans from it.

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    Example from the US: stimmel-law.com/en/articles/…. "The court disagreed with this and all of the husband's other arguments. It wanted proof that he intended to repay the advances, and that the corporation intended to require repayment. Since the husband could not convince the court that the withdrawals were loans, they were deemed to be constructive dividends."
    – Nate Eldredge
    Commented Dec 29, 2019 at 3:11
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    @NateEldredge that could be sufficient answer for the US if the actual case was referenced.
    – Greendrake
    Commented Dec 29, 2019 at 3:45

3 Answers 3

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Non-commercial loans aren’t loans

A company can legitimately lend shareholders money if it does so on commercial terms - over a realistic time frame at commercial interest and receives regular repayment of at least the interest and will ultimately receive the principal. The company will need to pay tax on its interest income and that interest may or may not be tax deductible for the individual. It it does all that, the advance is a loan; if it doesn’t, it isn’t.

Tax law treats loans that aren’t loans as what they are - dividends or salary and taxes you accordingly. And fines you for tax evasion.

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For example if you are a British actress and try that kind of stunt, you will suddenly find HMRC coming after you and all newspapers reporting about it (and nobody feeling sorry for you when HMRC tries to make you sell your home). The definition of “loan” includes repayment. If enough time goes past without any attempt at repayment, HMRC can unilaterally decide that it wasn’t a loan but salary or dividend payment and make you pay tax. However, if the company goes bankrupt and owes let’s say £70,000 in unpaid tax, they will find it more tax efficient to insist on immediate repayment of the loan.

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Tax evasion has an extremely loose definition. You don't even need to do that, there are corp to Corp evasions where you pay an LLC your salary so it never touched a "person" and was an equity investment and not income. If tax law was enforced literally then nobody would collect taxes. Taxes depend on the government arbitrarily grabbing things and law does not matter. If it did then there would be no way to prevent tax evasion since "income" and "wealth" take infinite forms

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