There are two unrelated businesses under common control (same owners). One is located here is the states the other is in the UAE. The company here in the states has issued several loans to the other company over the past few years. Loan agreements were created for most of the loans when the loans were issued. The loan agreements do specify an interest rate, but are 'on demand' loan agreements. The loan values range from $10k to $50k. The company here is the states that loaned the money has not recorded any interest income on any of the previous loans. Should interest income have been recorded? I've also discovered that the company that borrowed the money has not yet made any payments on any of the previously issued loans. The owners insist that this is an oversight and that payments will be made. What is the best way to journalize all of this. I have told the owners that I believe interest income for each loan must be added to the lenders books, but given the age of the loans, interest expense on the borrowers books may not be possible. I also pointed out that the IRS, and the UAE may consider these 'loans' as investments and not loans. Since no payments have been made, is recording the previously accrued interest required if they claim the debt is still good? Thank you!
Is interest required?
Answers
For US tax purposes, services that do have an economic value are taxable. Therefore, money lent by one legal entity generates interest income and must be treated in the accounts accordingly. Retroactive adjustment in the accounts is necessary and the accumulated interest must be calculated retroactively.
Accounting and taxation are however only one part of the issue I would be concerned if I would have to handle the accounting of this company.
Lending money between two legal entities are transactions that need to be supported by written documentation and such business decisions must be legally approved by someone who does have the legal authorities to do so. Unless granting loans to third parties is part of the regular business activity of the company, and the Board of Directors has the authority to enter such agreements, loan agreements must be approved by the shareholders and must be documented in the minutes of the meeting during which such loans have been approved.
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