Gifts, Loans and the Lawful Source Requirement

Very few investors write the check entirely from money they earned personally. Parents fund children, businesses distribute to owners, banks lend against property. The statute accommodates all of that and then attaches conditions, and the conditions are where petitions are won or lost.

What capital means before the gift question arises

Capital is cash and all real, personal or mixed tangible assets owned and controlled by the investor, or held in trust for the investor with unrestricted access. It is valued at fair market value in dollars at the time of investment, under generally accepted accounting principles or another standard accounting practice adopted by the Securities and Exchange Commission.

Three exclusions matter here. Assets acquired directly or indirectly by unlawful means are not capital, and neither are the cash proceeds of indebtedness secured by such assets. A contribution made in exchange for a note, bond, convertible debt, obligation or any other debt arrangement between the investor and the enterprise is not capital. Nor is a contribution carrying a guaranteed rate of return. The first exclusion is about the money's history; the other two are about the shape of the deal, and they belong with the requirement that capital be genuinely at risk.

The two conditions on gifts and loans

Gifted and borrowed funds may not be counted toward the required investment unless two things are true. They were gifted or lent to the investor in good faith. And they were not gifted or lent in order to circumvent the limitations on permissible sources of capital, including proceeds of illegal activity.

The second condition explains the first. A gift is a well-established way to launder the history of money: the recipient can point to a clean transfer and disclaim knowledge of what came before. The statute closes that by treating the donor's history as part of the investor's record, which is why the documentary requirement follows immediately.

What a donor or lender must produce

Where funds are gifted or lent, the petition must include, from the donor or from the lender if the lender is not a bank, the same two categories of records the investor supplies. That means business and tax records — foreign business registration records, corporate and personal tax returns of every kind filed anywhere over a seven-year period, and evidence identifying any other source of the funds — and evidence relating to monetary judgments and pending proceedings that could produce one.

The bank exception is narrow. It removes the records requirement for institutional lenders, not for a company, a business associate or a relative who happens to be lending rather than giving. Where a lender is a private individual, the practical effect is that the petition contains two complete source packages instead of one.

When borrowing funds the investment

The regulation states three requirements for investing indebtedness, and the agency's guidance applies them. The investor must be personally and primarily liable for the debt, with primary responsibility under the loan documents for repaying it. The indebtedness must be secured by assets the investor owns. And the assets of the enterprise being invested in may not be used to secure any part of it.

Where collateral is pledged, the borrowing qualifies as capital only up to the fair market value of the pledged assets. The collateral must be specifically identified as securing the debt and must be amenable to seizure by a noteholder in the United States. A promissory note used as capital is valued at present value, not face value, and nearly all of the money due under it must be payable within two years without provision for extension.

The documents that usually decide it

For a gift: a dated instrument identifying the parties and the amount, evidence that the transfer actually occurred, evidence of the relationship, and the donor's own source package. Tax treatment of the gift in the donor's jurisdiction is useful corroboration where it exists. What weakens a gift most reliably is a document created after the petition was prepared, describing a transfer that happened long before.

For a loan: the loan agreement, the security instrument, evidence of the investor's ownership of the collateral and its value, and evidence that repayments are being made where any have fallen due. Where the lender is not a bank, add the lender's source package. Where the funds crossed a border on their way to the enterprise, the transfer questions in moving capital out of a restricted-currency country apply on top of everything above.

Because a donor's or lender's records are often held by people with no stake in the outcome, this is the part of a petition that most often stalls. Investors who anticipate needing a relative's seven years of returns usually raise it with lawful source of funds attorney before the money moves rather than after a request for evidence arrives. The alternative is asking a reluctant family member for tax filings under a deadline, which is where otherwise sound cases fail.

How a defective source shows up later

Source of funds is not re-litigated wholesale at the removal of conditions stage, but it is not immune either. A finding that a petition was predicated on misrepresentation about the source or path of funds is a ground for revocation, and it reaches the derivative family members whose status depends on the principal, as described in how conditional residence begins and what ends it. A gift documented honestly at the outset is considerably cheaper than one reconstructed under examination.