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  1. Determine whether there is a true debtor-creditor relationship. Excessively large liabilities in relation to capital stock (especially in the case of a new company) may indicate a thin capitalization situation.
  2. Check the financial statements of the corporation as well as that of the shareholders. If there is an interest expense account on the part of the corporation from such loan, there should also be a corresponding interest income account on the part of the shareholder. There are certain tax advantages to the corporation or shareholder for an equity investment to be treated as a loan. Be sure that the taxpayer gets these benefits only when the facts of the case show that a “true loan” exists. If “loans” are found to be equity capital, the following procedures may be applied:
    1. Disallow claim for interest expense and treat payments during the year as dividends.
    2. Treat loan repayments as dividends.
    3. Disallow bad debts deductions by the shareholders.
  3. Check supporting loan documents issued in favor of the shareholders, officers or owners. If unsupported or if support is doubtful, the unreported income may have been lodged in this account.
  4. Verify certain payments of loans against check vouchers and cancelled checks.
  5. Verify the debit and credit entries in the general ledger account and watch out for unusual sources other than the cash receipts and disbursements book.
  6. Examine adjustments, specially increases in the account, at the end of the year as this may constitute shifting of taxable income to this liability account. Verify general journal entries, journal vouchers and related documents supporting the entries.


Reference: RAMO 1-2000