Loans to Board Members and Related Parties: A Risk Coming into Focus

For a long time, loans to board members, shareholders, and other related parties were perceived in business practice as a low-risk issue. They were not at the top of the State Revenue Service (SRS) priorities, and many companies concluded based on this: “if no one has asked anything so far, then everything is fine.”

This approach is gradually losing relevance. Not because the regulation itself has significantly changed, but because the way the SRS sees and analyzes data is changing. The availability of structured data means that loans that previously “did not stand out” will become easily noticeable.

Why Loans Are Becoming the Next Logical Step in SRS Analysis

Loans to related parties are inherently a suitable subject for analysis. They contain specific figures – loan amount, term, interest rate, payment schedule. There are no discussions about service quality or product characteristics. There is concrete data.

That is precisely why, in a structured data environment, such transactions become particularly transparent. If the interest rate does not correspond to the market, if the loan is not actually repaid, or if the transaction’s logic does not align with what unrelated parties would do, it can be noticed without in-depth investigation.

It is important to emphasize: currently, this is not yet a subject of mass control. However, given the overall trend towards data analytics, this is one of those areas where it is only a matter of time before the SRS starts paying increased attention to these transactions.

The Arm’s Length Principle Also Applies to Loans

The regulatory framework here is not new. Transactions with related parties, including loans to board members and shareholders, must comply with the arm’s length principle. This stems from corporate income tax regulations and Cabinet of Ministers Regulations No. 677.

In practice, this means a simple thing: the loan terms must be such as the company would be willing to offer to an unrelated party under similar circumstances. The interest rate, terms, and repayment mechanism must be economically justified, not based on trust, convenience, or an “internal agreement.”

Most Common Mistakes

Most often, the problem is not the loan itself, but the approach. The interest rate is determined intuitively, without reference to market data. The loan is formalized with a contract, but without real repayment discipline. Or the loan effectively replaces dividends, as it allows money to be withdrawn without immediate corporate income tax.

Such situations are not unique. However, in tax law, it is the economic substance, not the form, that is evaluated. If a loan does not essentially resemble a loan, the SRS will not treat it as such.

In practice, it is also observed that when it comes to evaluating interest rates, the SRS often relies on statistical averages. This approach has already been the subject of court disputes.

What This Means for Businesses Today

This is not a story about panic or urgent “firefighting.” It is a story about the time when loans to related parties remained outside the SRS’s control gradually coming to an end.

For companies thinking long-term, this is a moment to critically examine these transactions: are they structured in a way that they can be defended even if someone looks at them from the outside – with data and without context?

Brief Self-Assessment Checklist for Businesses

If a company has loans to board members or other related parties, it is worth honestly answering these questions:

1. is the interest rate justified by market data (e.g., bank offers or information compiled by the Bank of Latvia);
2. does the loan have a clear and actually observed repayment schedule;
3. are interest payments actually calculated and paid;
4. do the loan terms and conditions correspond to what the company would accept in a transaction with an unrelated party;
5. has the loan not become a permanent cash flow without a clear economic purpose.

If, after reading this list, doubts arise about any of the loans, this alone does not yet mean that there is a tax risk. However, it is a signal that the transaction structure and justification are worth reviewing in a timely manner.

Our office regularly helps companies evaluate loans to board members and other related parties – both preventively and in situations where the SRS has already raised questions. The earlier such an evaluation is carried out, the simpler and calmer it is to resolve.

If you are unsure about the compliance of a loan with the arm’s length principle, feel free to contact us – often, a single conversation is enough to understand if there is a risk and how to mitigate it.