The post-A-day regime has one set of investment rules which applies to all registered schemes. It should be noted that the new rules apply to all investments, even where these were made prior to 6 April 2006 with the exception of those relating to loans, scheme borrowing and the transitional provisions in respect of ‘taxable property’(see below). The new regime (subject to any relevant DWP, FSA or other general restrictions outside tax law) allows pension schemes to invest in all types of investment, including residential property. However, changes in the Finance Act 2006 included provisions so that tax charges apply where an ‘investment regulated pension scheme’ holds investments that are ‘taxable property’. ’Taxable property’ consists of residential property and most tangible moveable assets. The effect of the tax charges is to make investments in ‘taxable property’ extremely unattractive.
It is generally left to the trustees/scheme administrator to decide if an investment is appropriate. General trust law requires the trustees to act prudently, conscientiously and honestly when making decisions in respect of the scheme. Trustees should at all times act in the best interests of scheme members in their capacity as trustees and not as employees, shareholders etc. When deciding the scheme’s investment policy, the administrators/trustees should bear carefully in mind the need to have sufficient liquid funds to pay pension benefits.
However, there are a certain number of investment rules which are being applied which are set out later in this section.
Registered pension schemes are exempt from any liability to tax on income on any investment income where the investment is held for the purpose of the scheme. This includes:
- income derived from investments or deposits
- underwriting commissions if they would otherwise be chargeable to tax under Case VI of Schedule D
- income from, or income derived from, transactions relating to, futures contracts and options contracts
- profits or gains arising from transactions in certificates of deposit
- profits from sale and repurchase agreements (repos) and ‘manufactured payments’
- relevant stock lending fees received by a registered scheme
A gain arising from the disposal of investments held for the purposes of the scheme is exempt from capital gains tax (section 271 Taxation of Capital Gains Act 1992).
The income and gains arising from ‘taxable property’ do not benefit from the above tax exemptions and are subject to a scheme sanction charge.
The above exemptions do not apply to income derived from investments or deposits held as a member of a property investment Limited Liability Partnership. In addition where a scheme makes a gain in their capacity as a member of a property investment Limited Liability Partnership the normal capital gains tax exemption do not apply.
A registered pension scheme is liable to pay tax on any income derived from a trading activity. Trading income is assessed to tax in the normal way and does not qualify for the particular tax exemptions that apply to income from investments. Trading income of a registered pension scheme must be included on a self assessment tax return.
There is no objection in principle to a registered pension scheme entering into transactions with a member or a person/company connected with a member. However, as indicated below, various tax charges are imposed where any investment transactions entered into by the scheme (involving assets or liabilities) with people connected to the scheme are not on arm’s length terms.
Any transaction between a registered pension scheme and
- the member or sponsoring employer of the scheme
- people connected with scheme members and or connected employers. For this purpose ‘connected’ is as defined in section 993 of the Income Tax Act 2007
- a third party, which is directly or indirectly for the benefit of a scheme member or sponsoring employer of the scheme which is not on arm’s length terms, will result in the excess value (ie. over and above arm’s length terms) being taxed as an unauthorised payment.
For example, if a scheme sells an asset worth £1 million to a scheme member at a price of £600,000, there is a value of £400,000 that has been passed to the member and which is taxed as an unauthorised payment.
A particular issue could arise in adverse economic conditions where renegotiation of a lease for commercial property could be a sensible course of action, possibly leading to reduced rental income. HMRC has confirmed that this is possible where the tenant is connected to the pension scheme member (e.g. the sponsoring employer) provided that there is evidence that the re-negotiation has been conducted in the same way as it would have been for an unconnected tenant and that the scheme administrator has acted in the best interests of the scheme members. Where the tenant is a company HMRC would not expect to see dividends paid to shareholders where the company is being treated as unable to afford to pay the full amount of rent that is legally due.
Similarly, where a connected party misses a rental payment this does not necessarily immediately become an unauthorised payment it it ie pursued on an arms-length basis. HMRC would expect evidence of how the rent has been pursued on a commercial basis to be produced if requested. It is important that a scheme administrator pursues this commercially, and seeks suitable professional (and independent) help and advice, as evidence.
The Government included changes in the Finance Act 2006 to make provision for tax charges where an ‘investment regulated pension scheme holds investments that are ‘taxable property’ (section 174A and schedule 29A of the Finance Act 2004).
‘Taxable property’ consists of residential property and most tangible moveable assets (ie. things that you can move and touch, including art, antiques, jewellery, fine wines, stamp collections, rare books, classic and vintage cars and yachts). Certain tangible moveable property, as specified in Regulations, are not subject to tax charges. These will generally be items of a type that are normally held as investments and do not provide any possibility of personal use. Investment grade gold bullion (ie. gold of a purity not less than 995 thousandths, which is in the form of a bar, or of a wafer, of a weight accepted by the bullion markets) is exempted from such a tax charge under the Investment-regulated Pensions Schemes (Exception of Tangible Moveable Property) Order 2006 – SI 2006/1959.
The Government has provided very detailed notes on what constitutes residential property and tangible moveable assets. The following is only a very brief description of some of the aspects and the Government document should be referred to for the full information.
Residential property can be in the UK or elsewhere and is a building or structure, including associated land, used or suitable for use as a dwelling. Residential property includes a beach hut, and a hotel (including an inn) where it provides accommodation rights such as a timeshare. The following are not treated as residential property for this purpose:
- a dedicated children’s home
- a hall of residence for students. Pensions Tax Simplification Newsletter No.18 clarifies what is meant by a ‘hall of residence for students’. HMRC explain that a ‘hall of residence’ does not need to be owned by the education establishment whose students are the sole occupants. But in order to be a ‘hall of residence’ it does need to be connected to a particular educational establishment and provide accommodation on a communal basis for students of that establishment only. There are a number of factors below which assist in determining whether or not the property in question is a ‘hall of residence’:
· an educational establishment identifies the property as one of its halls of residence;
· the educational establishment is involved in placing its students in the building;
· the students occupying the building are limited to a single educational establishment;
· the building may be sited on college campus or grounds;
· the building is not broken up into self-contained apartments with one or more bedrooms;
· there are common living areas or eating/cooking facilities or services provided in the building for the use of all occupants;
· the self-contained apartments cannot be acquired and disposed of separately.
It is clear from the above that to be a ‘hall of residence’ it is not sufficient that the accommodation is or may only be let to students. Self-contained apartments within a larger building will be residential property in their own right, not one or more ‘halls of residence’.
- an elderly persons’ care home (or homes providing care for those with disability, past or present dependence on alcohol or drugs, or past or present mental disorder)
- a hospital or hospice
- a prison or similar establishment
- any building specified in Regulations as not to be treated as residential property.
The definition of residential property does not apply to property, including land, which is not residential property when the ‘investment regulated pension scheme’ (see section 3 below) acquires it. However, it may become residential property while owned by the pension scheme as a result of being subsequently subject to development. Land and buildings being converted to residential property are treated as residential property from the point they become suitable for use as a dwelling.
The following two categories of ‘job related’ residential property are not ‘taxable property’:
(i) where the property is occupied by an employee who
- is neither a member of the pension scheme nor connected with such a member
- is not connected with the employer, and
- is required as a condition of employment to occupy the property
A good example of this is a caretaker’s flat.
(ii) where the property is occupied by a person who
- is neither a member of the pension scheme nor connected with such a member, and
- is used in connection with business premises held as an investment of the pension scheme
A good example of this is a flat above a shop that is leased from the scheme with the shop, where the flat is occupied by the trader in connection with them operating their trade from the shop.
The provisions apply to ‘taxable property’ that is held directly and also to indirect holdings of property except through genuinely diverse commercial vehicles. An indirect interest in ‘taxable property’ is held through a ‘vehicle’ i.e., a person or entity through whom the pension scheme holds the interest in the property. So if a pension scheme holds 100% of the share capital of a company which itself owns residential property then the company through which the pension scheme owns the property is the vehicle. There are three categories of genuinely diverse commercial vehicles:
- UK Real Estate Investment Trusts (REITs)
- Other kinds of vehicle
- Trading concerns
(a) UK REITs This is provided that the pension scheme does not directly or indirectly hold an interest in the UK REIT for the purposes of enabling a pension scheme member or a connected person of such a member to occupy or use the property
(b) Other kinds of vehicle (ie. vehicles which meet certain conditions ,where the pension scheme, and associates, directly or indirectly, own 10% or less and there is no right to private use of any taxable property).
The conditions are:
· the total value of the assets held directly by the vehicle is at least £1 million, or the vehicle holds at least three assets directly which are residential property, and in either of these cases no asset held directly by the vehicle which is ‘taxable property’ has a value that exceeds 40% of the total value of the assets held directly by the vehicle.
The £1 million and 40% figures above may be amended by Treasury order.
· If the vehicle is a company it is either
a. Resident in the UK and is not a close company, or
b. Not resident in the UK and would not be a close company if it were resident in the UK
- it does not have as its main purpose, or one of its main purposes, the direct or indirect holding of an animal(s) used for sporting purposes.
The pension scheme’s interest in the vehicle must meet the following conditions:
· the pension scheme does not directly or indirectly hold an interest in the vehicle for the purposes of enabling a member of the pension scheme or a connected person of a member to occupy or use the property
· where the pension scheme is an occupational scheme, it together with any ‘associated person’ (see below) does not hold directly or indirectly an interest in the vehicle that exceeds any one of the limits set out below. Similarly where the pension scheme is not an occupational scheme, no arrangement under the pension scheme together with any ‘associated person’, does not hold directly or indirectly an interest in the vehicle that exceeds any one of the limits below.
The limits are:
· 10% or more of the share capital or issued share capital of the vehicle
· 10% or more of the voting rights in the vehicle
· A right to receive 10% or more of the income of the vehicle
· Such an interest in the vehicle as gives an entitlement to 10% or more of the amounts distributed on a distribution in relation to the vehicle
· Such an interest in the vehicle as gives an entitlement to 10% or more of the assets of the vehicle on a winding up or in any other circumstances
· Such an interest in the vehicle as gives rise to income and gains derived from a specific property.
A pension scheme which is not an occupational scheme may have holdings in a vehicle through one or more arrangements for members that are not connected. In these circumstances the tests of whether 10% or more of the vehicle is owned will apply separately for each arrangement.
The term ‘associated person’ in relation to an occupational scheme means
· any member of the scheme
· any person connected with such a member
· any arrangement (under that or another pension scheme) relating to a member of the pension scheme
· any arrangement (under that or another pension scheme) relating to a person connected to such a member
· any associated pension scheme (ie. if members representing at least 10% by value of one pension scheme are members of the other pension scheme or connected with such members)
The term ‘associated person’ in relation to an arrangement under a scheme that is not an occupational scheme means
· the member of the pension scheme to which that arrangement relates
· any person connected with such a member
· any arrangement (under that or another pension scheme) relating to a member of the pension scheme to which that arrangement relates
· any arrangement (under that or another pension scheme) relating to a person connected to such a member
‘Connected person’ is as defined in section 993 of the Income Tax Act 2007.
(c) Trading concerns. There are 4 conditions to be met for vehicles that are arms length trading vehicles. These are:
· the vehicle’s main activity is carrying on of a trade, profession or vocation
· the pension scheme either alone or together with associated persons does not have control of the vehicle
· neither a pension scheme member nor a person connected to such a member is a controlling director of the vehicle or any other vehicle which holds an interest in the vehicle directly or indirectly
· the pension scheme does not directly or indirectly hold an interest in the vehicle for the purposes of enabling a pension scheme member or connected person of such a member to occupy or use the property.
For this purpose ‘control’ has the meaning in section 416 ICTA 1988, and the term ‘associated person’ in relation to the pension scheme means:-
· any member of the pension scheme
· any person connected with such a member
· any arrangement (under that or another pension scheme) relating to a member of the pension scheme
· any arrangement (under that or another pension scheme) relating to a person connected to such a member
· any associated pension scheme (as defined above)
This enables pension schemes to invest commercially in trading concerns without worrying about tangible moveable property that is being used by the company for its trade.
As the above definitions of trading concerns effectively exclude businesses controlled by scheme members, HMRC has introduced a specific limited exemption for investment in certain tangible moveable property. Indirect holding of tangible moveable property that meets the following conditions, as set out in the Investment-regulated Pension Schemes (Exception of Tangible Moveable Property) Order 2006 – SI 2006/1959 is not regarded as ‘taxable property’.
· the market value of the asset must not be greater than £6,000
· the asset is held solely for the purposes of the administration or management of the vehicle that it holds directly
· neither a scheme member, nor anyone connected to a scheme member personally occupies or has use of the asset or has any right to occupy or use the property.
The inclusion of this exemption prevents any ‘taxable property’ tax charges arising in respect of low value assets (eg. plant and machinery and office equipment) that are used in the normal operation of the vehicle’s business. Without this exemption, investment in an employer’s shares would virtually always result in the indirect ownership of ‘taxable property’.
‘Investment Regulated Pension Scheme’
For a scheme that is not an occupational scheme, an ‘investment regulated pension scheme’ is one where one or more of its members is or has been able (whether directly or indirectly) to direct, influence or advise on the manner of investments held for the purposes of the arrangement under the scheme relating to the member. It also applies where the condition is satisfied by a person related to the member.
For occupational pension schemes an ‘investment regulated pension scheme’ is one where,
· it has at least one member who meets the self-direction condition (see above paragraph) and has less than 50 members, or
· it has at least 10% of members who meet the self-direction condition
An ‘investment regulated pension scheme’ can also be generated by an occupational scheme that is not itself an investment regulated pension scheme but where one or more of its members (or a person related to one of the members) is or has been able (whether directly or indirectly) to direct, influence or advise on the manner of investments linked to an arrangement under the scheme relating to the member. In such a case it will be that arrangement that is treated as an ‘investment regulated pension scheme’.
The Finance Act 2008 changed the definition of an ‘investment regulated pension scheme’ as it relates to occupational pension schemes so that it does not include schemes where individual members could not realistically be expected to influence scheme decisions to invest in ‘taxable property’. This change is to stop large occupational schemes, in particular, falling foul of the ‘taxable property’ rules and has been backdated to 6 April 2006.
The revised definition indicates that an occupational pension scheme will be regarded as an investment-regulated pension scheme where at least one member meets the self-direction condition and where it has fewer than 50 members. This will mean that all occupational schemes with 50 or more members are excluded from the taxable property provisions.
It should, however, be remembered that individual members of such schemes can still fall foul of the taxable property provisions. This would apply where one or more of the members (or a person related to a member) is or has been able (whether directly or indirectly) to direct, influence or advise on the manner of investments linked to an arrangement under the scheme relating to the member. In such a case that arrangement would be treated as an investment regulated pension scheme. This is designed to stop large occupational schemes setting up separate sections of their scheme that will allow particular groups of members to direct that their funds are invested in taxable assets.
For the purpose of the above definitions, persons are related to the member if
· the person and the member are connected persons, or
· the person acts on behalf of the member or a person connected with a member and connected person is as defined in section 993 of the Income Tax Act 2007.
s993 Meaning of ‘connected’ persons
1. This section has effect for the purposes of the provisions of the Income Tax Acts which apply this section.
(1) An individual (‘A’) is connected with another individual (‘B’) if—
(a) A is B’s spouse or civil partner,
(b) A is a relative of B,
(c) A is the spouse or civil partner of a relative of B,
(d) A is a relative of B’s spouse or civil partner, or
(e) A is the spouse or civil partner of a relative of B’s spouse or civil partner.
(2) A person, in the capacity as trustee of a settlement, is connected with—
(a) any individual who is a settlor in relation to the settlement,
(b) any person connected with such an individual,
(c) any close company whose participators include the trustees of the settlement,
(d) any non-UK resident company which, if it were UK resident, would be a close company whose participators include the trustees of the settlement,
(e) any body corporate controlled (within the meaning of section 995) by a company within paragraph (c) or (d),
(f) if the settlement is the principal settlement in relation to one or more sub-fund settlements, a person in the capacity as trustee of such a subfund settlement, and
(g) if the settlement is a sub-fund settlement in relation to a principal settlement, a person in the capacity as trustee of any other sub-fund settlements in relation to the principal settlement.
(3) A person who is a partner in a partnership is connected with—
(a) any partner in the partnership,
(b) the spouse or civil partner of any individual who is a partner in the partnership, and
(c) a relative of any individual who is a partner in the partnership. But this subsection does not apply in relation to acquisitions or disposals of assets of the partnership pursuant to genuine commercial arrangements.
(4) A company is connected with another company if—
(a) the same person has control of both companies,
(b) a person (‘A’) has control of one company and persons connected with A have control of the other company,
(c) A has control of one company and A together with persons connected with A have control of the other company, or
(d) a group of two or more persons has control of both companies and the groups either consist of the same persons or could be so regarded if (in one or more cases) a member of either group were replaced by a person with whom the member is connected.
(5) A company is connected with another person (‘A’) if—
(a) A has control of the company, or
(b) A together with persons connected with A have control of the company.
(6) In relation to a company, any two or more persons acting together to secure or exercise control of the company are connected with—
(a) one another, and
(b) any person acting on the directions of any of them to secure or exercise control of the company.
994 Meaning of ‘connected’ persons: supplementary
(1) In section 993 and this section ‘company’ includes any body corporate or unincorporated association, but does not include a partnership (and see also subsection (2)), ‘control’ is to be read in accordance with section 416 of ICTA (except where otherwise indicated), ‘principal settlement’ has the meaning given by paragraph 1 of Schedule 4ZA to TCGA 1992, ‘relative’ means brother, sister, ancestor or lineal descendant, ‘settlement’ has the same meaning as in Chapter 5 of Part 5 of ITTOIA 2005 (see section 620 of that Act), and ‘sub-fund settlement’ has the meaning given by paragraph 1 of Schedule 4ZA to TCGA 1992.
(2) For the purposes of section 993—
(a) a unit trust scheme is treated as if it were a company, and
(b) the rights of the unit holders are treated as if they were shares in the company.
(3) For the purposes of section 993 ‘trustee’, in the case of a settlement in relation to which there would be no trustees apart from this subsection, means any person—
(a) in whom the property comprised in the settlement is for the time being vested, or
(b) in whom the management of that property is for the time being vested. Section 466(4) does not apply for the purposes of this subsection.
(4) If any provision of section 993 provides that a person (‘A’) is connected with another person (‘B’), it also follows that B is connected with A.
995 Meaning of ‘control’
(1) This section has effect for the purposes of the provisions of the Income Tax Acts which apply this section.
(2) In relation to a body corporate (‘company A’), ‘control’ means the power of a person (‘P’) to secure—
(a) by means of the holding of shares or the possession of voting power in relation to that or any other body corporate, or
(b) as a result of any powers conferred by the articles of association or other document regulating that or any other body corporate, that the affairs of company A are conducted in accordance with P’s wishes.
(3) In relation to a partnership, ‘control’ means the right to a share of more than half the assets, or of more than half the income, of the partnership.
If the amount of scheme chargeable payments in a 12 month period reaches the relevant threshold the scheme could be de-registered. HMRC has, however, indicated that it would not normally view a one-off acquisition of ‘taxable property’ as something that would lead to de-registration even where the relevant threshold is breached. De-registration will be considered in exceptional cases (eg. the multiple purchases of ‘taxable property’, or where avoidance or evasion is present).
The following example will help to demonstrate how tax is levied on ‘taxable property’.
In June 2010 David Phillips used all of the monies in his SIPP to buy a three bedroomed house costing £350,000. It generates rental income, after expenses of £18,000 a year. The house is regarded as ‘taxable property’. The tax charges are:
|Person liable||Tax charge||Levied on (£)||Tax Rate (%)||Amount of Tax Due (£)|
|David||Unauthorised member payment||350,000||40||140,000|
|David||Unauthorised payments surcharge||350,000||15||52,500|
|Scheme administrator||Scheme sanction charge||350,000||15||52,500|
In addition to the above if HMRC decided to de-register the scheme as the ‘taxable property’ represents more than 25% of the scheme a further charge, payable by the scheme administrator, of £119,000 (ie. 40% of the value of scheme assets – £350,000 less the scheme sanction charge of £52,500).
In the first year the scheme administrator also faces a £14,000 tax charge (ie. 40% on deemed income of £35,000). There is also a scheme sanction charge of 40% on any realised capital gains.
‘Taxable Property’ – Transitional Protection
Up to 6 April 2006 pension schemes were able to hold interests both directly and indirectly in some types of residential property and in some cases, tangible moveable property.
The above ‘taxable property’ provisions do not apply, subject to certain conditions, for taxable assets that were legitimately held under the rules operating before 6 April 2006 and which are not improved. Similar protection applies for indirect holdings in taxable assets legitimately held before 6 April 2006.
The following table sets out a list of the types of scheme and investments that are subject to transitional protection.
|Type of scheme and investment||Availability of Transitional Protection|
|SIPPs, SSAS and S.226
- Direct investment in residential property
|- Not available – if the purchase of residential property was not allowed under pre A-Day rules(c) where certain narrow classes of residential property were allowed under pre A-Day rules they will be protected provided they are not materially improved (except where such improvements are undertaken wholly to comply with a statutory requirement or requirement of a statutory body) on or after that date. These include investments in ground rents, feu duties and property related to an employment for an employee unconnected with the pension scheme.|
|SIPPs and SSAS
- Off-plan purchases (or property that is not fit for use as residential property)
|- If the investment was made before midnight on 5 December 2005 and the off-plan investment does not subsequently become residential property after 5 December 2005 it will be protected.- There is no protection for any off-plan purchases made on or after 5 December 2005.|
|SIPPs, SSAS and S.226
- Indirect investment in residential property or where property purchased directly under the pre-1991 rules for SSAS
|- Where an indirect investment is made before midnight on 5 December 2005 and that investment is not explicitly prohibited under the current regime it will be protected, provided it is not materially improved (except for a statutory requirement) after 5 December 2005. There will be no protection if there is any post 5 December 2005 material improvement expenditure (unless for a statutory requirement).- Where a property was purchased by a SSAS under the pre 1991 rules the investment will be protected, provided it is not materially improved (except for a statutory requirement) after midnight on 5 December 2005. There will be no protection if there is any post 5 December 2005 material improvement expenditure (unless for a statutory requirement).There will be no protection if the indirect investment is not allowed under the current regime.|
|Section 590 schemes
- Direct and indirect investment in residential property
|- All purchases of residential property made before A-Day, by one of these schemes which was set up and approved before midnight on 5 December 2005 will be protected, provided they are not materially improved (except for a statutory requirement) on or after 6 April 2006.- No protection for any investments in residential property made by a s.590 scheme set up and approved after midnight on 5 December 2005|
Where a SIPP has acquired a property, eg. off-plan, with the intention of holding it as an investment but because of the introduction of the ‘taxable property’ changes, it is decided to dispose of the property, HMRC will consider in each case whether the disposal is regarded as trading or investment. Advice on this can be found in the Business Income Manual at BIM 60000 onwards. However, the transaction is unlikely to be regarded as a trading one unless there has been a change of intention (of the type discussed in BIM 60060) normally resulting in some form of physical change to the asset.
In the case of off-plan, the fact that it was in the process of being developed as at 5 December 2005 in accordance with the contract originally entered into between the developer and the SIPP, would not make it a trading transaction for the SIPP where the development continues.
Investment in shares of sponsoring employer
There is a limit on holdings of shares in the sponsoring employer of 5% of a scheme’s assets or 20% of scheme assets where they relate to more than one sponsoring employer. In the latter case the amount that may be held in respect of any one employer is limited to 5% of scheme assets.
However this restriction does not apply to registered schemes that are not ‘occupational pension schemes’ as defined in the Finance Act 2004. Therefore a registered scheme established as a SIPP could invest up to 100% of the scheme assets in shares of the ‘sponsoring employer’. (This is provided that the employer did not set up a trust for the SIPP because the trust would mean the SIPP would be classified as an ‘occupational scheme’ under the new regime).
The percentage of value is calculated at the time the payment is made for the shares by the scheme, and is not re-tested at a later date, unless new shares in the sponsoring employer are acquired. There are no restrictions with regard to the percentage of shares which can be held in one company (eg. a registered scheme could potentially own 100% of the share capital of a company) provided that the sums invested are less than 5% of the fund value.
Where the 5% or 20% limits are exceeded, the amount is subject to an unauthorised payments charge on the employer. The scheme is also subject to a scheme sanction charge.
Where a scheme already held shares in a sponsoring employer prior to 6 April 2006 the shares may continue to be held. If, however, the scheme purchases shares in a sponsoring employer after 6 April 2006 the 5% limit will apply and the total holding of shares including the value of the shares held prior to 6 April 2006 will have to be taken into account.
When considering investment in unquoted shares of the sponsoring employer full account should be taken of the provisions in respect of ‘taxable property’ (see section 2) above introduced by the Finance Act 2006. In particular the complex rules on indirect holdings of ‘taxable property’ could prevent a SIPP from holding any shares in the employer of a member.
Loans are only acceptable if they are genuine investments of a pension scheme. They should be prudent, secure and on a commercial basis. There is, however, no legislative restriction on the purposes for which a loan to a sponsoring employer may be used where it is made on or after A-Day.
Although a loan to a member, or former member is possible it is always treated as an unauthorised payment equal to the amount of the loan. Similarly a loan to a person connected to the member is treated as an unauthorised payment to the member (unless the connected person is also a scheme member when it will be treated as a unauthorised payment to the connected person.)
Loans may, however, be made to an unassociated third party (ie. not connected to members or sponsoring employers). Such loans must normally be on an arms length basis on commercial terms. Care should be taken with any loan to a ‘third party’. While the ‘third party’ may not be a ‘connected person’ (eg a company of which a scheme member, or a person connected with the member, is a director but does not control the company directly) the borrowing ‘third party’ could still be a ‘sponsoring employer’ as defined below. In which case the loan would need to meet the five conditions set out below to be an authorised employer loan, or otherwise it will be an unauthorised employer payment.
If a loan is to a trading company of which the member or a connected person is a controlling director but the company is neither a ‘sponsoring employer’ (see below) nor controlled directly or indirectly by the member or a connected person the ‘taxable property’ rules will apply (as the ‘taxable property’ exemption in respect of a trading company is only applicable in respect of an authorised employer loan). This would result in an unauthorised payment charge on the employer.
Loans to ‘sponsoring employers’, other than in the form of bonds issued on the open market, must comply with each of the five key tests, set out later in this note, to be an authorised employer loan. Any loan not meeting any of the five criteria will be an unauthorised payment and result in an unauthorised payment tax charge on the scheme administrator at 40%.
A ‘sponsoring employer’ is defined in section 150(6) of the Finance Act 2004 and means in relation to an occupational pension scheme ‘the employer, or any of the employers , to or in respect of any or all of whose employees the pension scheme has, or is capable of having effect so as to provide benefits’. From this it appears than an authorised employer loan can only be made to an employer by an occupational pension scheme, whose rules enable that employer to provide benefits for its employees via the scheme. However, unless the pension scheme is incapable of providing benefits for members who are employees (including directors) of an employer then the employer would seem to be a ‘sponsoring employer’ whether or not it is associated with a participating employer.
The whole question of who constitutes a ‘sponsoring employer’ is highly complex and while we believe the above accurately reflects the definition in section 150(6) we would strongly recommend that legal advice be taken where the intention is to make a loan to a non participating employer. If an employer is not a ‘sponsoring employer’ but is controlled directly or indirectly, by a member of the pension scheme or a person connected with that member, any loan to that employer by the scheme would constitute an unauthorised member payment.
It should be noted that such loans to a sponsoring employer can only be made from an employer sponsored registered scheme (ie. normally an occupational scheme). It would not be possible for such a loan to be made from a SIPP. Where a loan is made by a registered scheme that is not an occupational scheme to an employer who is connected to the member this will result in a tax charge on the member.
Any guarantee of a loan, made by a registered scheme to
· a sponsoring employer, or
· a member of the scheme, or
· a person who is connected to the sponsoring employer or the member is treated as a loan and is subject to the same requirements below as set out for a loan. The amount of the loan is equal to the amount guaranteed by the scheme.
Five conditions for an authorised employer loan
(i) be secured as a first charge on assets that are at least equal to the loan. Subsequent falls in the value of the security are permitted, provided these are not the result of actions taken by the employer or connected persons. The charge must take priority over any other charge on the assets.
Where the asset used as security is replaced by another asset, the value of the replacement must be at least equal to the lower of the market value of the asset it has replaced or the amount of the loan outstanding plus interest at the time the security is replaced.
(ii) have an interest rate equal to the average of the base lending rates of the following companies, plus 1%.
- the Bank of Scotland
- Barclays Bank Plc
- HSBC Bank Plc
- Lloyds TSB Bank Plc
- National Westminster Bank Plc, and
- The Royal Bank of Scotland Plc
The interest rate calculation is prescribed in the Registered Pension Schemes (Prescribed Interest Rates for Authorised Employer Loans) Regulations 2005 – SI 2005/3449
Where the average is a multiple of 0.25% that will be the rate. Where it is not such a multiple the average should be rounded up to the next multiple of 0.25%. This calculation is undertaken on the ‘reference date’ (ie. the 12th working day of the month preceding the ‘operative date’). For this purpose the ‘operative date’ is the 6th working day of the month concerned and the rate so calculated applies for a month. It appears that a recalculation of the rate is required for each subsequent month of the term of the loan.
A scheme may make a loan at a fixed rate of interest as long as that interest rate is at least the rate specified at the time the loan is advanced. As long as the terms of the loan remain unchanged there is no requirement to alter the interest charged on the loan during its life.
(iii) be for a term of less than 5 years. The total amount owing (including interest) must be repaid by the loan repayment date. There are no restrictions regarding liquidity considerations when determining the date by which a loan must be repaid, eg before a member’s retirement date, apart from the amount of the loan. It is therefore entirely a matter for the trustees to decide when a loan should be repaid, subject to the 5 year limit, having regard to the likelihood of paying retirement benefits at some future date.
(iv) be no more than 50% of the market value of scheme assets as at the date the money is loaned by the employer. This limit is not retested subsequently if there is a fall in the value of the scheme’s assets unless the terms of the loan are changed. Any further loan advances to the employer are treated as a new loan and the 50% limit is retested at that time.
(v) be repaid either by equal instalments of capital and interest for each complete year of the loan.
There is also only one opportunity for schemes to roll over a loan (ie. where there are amounts owing on the 5th anniversary) and only then for a maximum extension period of 5 years. This allows a loan to be extended where the sponsoring employer is having genuine difficulties making repayments without having to find replacement security for the loan if the original security has fallen in value
Where the above terms are not complied with the loan will be seen as an “unauthorised employer payment”, which if large enough could result in HMRC withdrawing the registration of the scheme. Trustees are expected to enforce the repayment terms. However, care should be exercised where the sponsoring employer has given security on residential property or other ‘taxable property’ which it owns because enforcing repayment in specie rather than in cash realised from the sale of such a secured asset will trigger an unauthorised payments charge under the ‘taxable property’ provisions.
The unauthorised payment is calculated separately for each one of the five tests failed. However, to avoid double charging, if the loan fails on more than one of the tests the unauthorised payment is the greatest amount calculated in respect of all of the failed tests. In any event the payment must not exceed the amount of the loan when it was made. The unauthorised payment charge arising in respect of each of the above five tests is described below.
(i) If a loan ceases to be secured after it is made or the asset is not secured as a first charge, an unauthorised payment charge arises on the amount outstanding plus interest. If any transaction by the sponsoring employer or a person connected with the employer, reduces the value of a security, an unauthorised payment charge arises on the amount of the reduction in the charge where a replacement security is not equal to the lower of the value of the former security and the amount of the loan outstanding. For example,
Albion Ltd registered pension scheme makes a loan to Albion Ltd of £250,000. Albion Ltd offers a property valued at £300,000 as security. One year later Albion Ltd sell the property and replace the security with another property worth £200,000. The amount of loan outstanding (including interest) is £230,000. This will result in an unauthorised payment charge of £12,000 (ie 40% x £30,000 – the difference between the loan outstanding and the value of the replacement security)
(ii) If the interest rate charged on a loan is less than the prescribed rate an unauthorised payments charge arises on the loss of interest involved. This is determined using the formula
(100-[IR/PIRx100] / 100 ) x AO
IR is the actual rate of interest payable on the loan
PIR is the prescribed rate of interest
AO is the amount of loan outstanding (excluding interest).
For example, Arsene Ltd registered pension scheme makes a loan to Arsene Ltd of £50,000 at an interest rate of 4.5%, when the prescribed rate is 5%.
The amount of the unauthorised payment is:
(100-[4.5/5 x 100]) / x £50,000 = £5,000
Arsene Limited will be subject to an unauthorised payments charge of £2,000 (ie 40% x £5,000), and Arsene Ltd registered pension scheme will be subject to a scheme sanction charge.
(iii) If the term of a loan exceeds 5 years (and it has not been rolled over in accordance with the conditions set out earlier in this section) an unauthorised payments charge will apply in accordance with the following
([DLRP/DFY x 100]) / 100 - 100 x AO
DLRP is the total number of days from the date the loan is taken out to the actual loan repayment date.
DFY is the number of days in 5 years
AO is the loan amount outstanding (including interest) at the beginning of the loan or when the terms of the loan are altered
For example, Heather Ltd registered pension scheme makes a loan of £10,000 on 6 April 2006 to Heather Ltd. The loan repayment date is 5 October 2011.
The unauthorised payments charge is:
([2009/1826 x 100] / 100 ) - 100 x £10,000 = £1,002
Heather Ltd will pay 40% x £1,002 = £400.80
Heather Ltd registered pension scheme will be subject to a scheme sanction charge.
(iv) Where a loan exceeds the 50% limit at the time it is made, an unauthorised payment charge arises on the difference between the amount of the loan and 50% of the value of the fund before the loan was made.
(v) If loan repayments are not made in equal annual instalments, an unauthorised payments charge arises on the largest amount of the difference between the ‘required amount’ and the total amount payable during a 12 month loan period.
The amount of capital and interest repayments payable each loan year (the ‘required amount’) is calculated using the formula
[L + TIP/TLY] x NLY
L is the amount of the loan
TIP is the total interest payable
TLY is the total number of loan years, and
NLY is the number of loan years in the period
For example, Falcon Ltd registered pension scheme makes a loan to Falcon Ltd of £50,000 on 1 January 2007 for a period of 5 years. The total interest chargeable on the loan over the period is £20,000. The following repayments must be made by Falcon Ltd.
[(£50,000 + £20,000/5] x1 = £14,000
If in the above example the loan agreement provided for the following payments to be made:
|Year 1||£10,000 (difference from required payment is £4,000)|
|Year 2||£18,000 (nil)|
|Year 3||£12,000 (£2,000)|
|Year 4||£14,000 (nil)|
|Year 5||£16,000 (nil)|
The unauthorised payment is determined on the highest deficit (ie £4,000 in this case) in the 5 years.
The unauthorised payment charge is therefore £4,000 x 40% = £1,600
The scheme will also be subject to a scheme sanction charge.
Loan made to Employer Prior to A – Day
Where an occupational pension scheme made a loan to a sponsoring employer before 6 April 2006, the existing loan is not subject to the new rules provided
- the occupational scheme became a registered pension scheme
- there is no alteration in the repayment terms of the loan after 5 April 2006
- the repayment date of the loan (capital and interest) is after 6 April 2006.
If after 6 April 2006 there is a change in the repayment terms, any amount arising (including interest) will be subject to the new rules.
A postponement of the repayment date will not be treated as a change in repayment terms if
- there is an amount outstanding on the date which the amount should have been paid
- the rollover does not exceed 5 years
- there has been no previous rollover on or after 6 April 2006
- there are no other changes to the repayment terms of the original loan.
Impact of DWP Legislation
The DWP continue to place restrictions on loans by occupational schemes to sponsoring employers. These are set out in the Occupational Pension Schemes (Investment) Regulations 2005 – SI 2005/3378.
An occupational scheme, other than a ‘small scheme’, may not invest more than 5% of the current market value of the scheme’s resources in employer-related investments, and none of the scheme resources may be used to provide a loan to the employer.
A ‘small scheme’ means a scheme with fewer than 12 members, where
(a) all members are trustees of the scheme and either
(i) the provisions of the scheme provide that all decisions which fall to be made by the trustees are made by the unanimous agreement of the trustees who are members of the scheme, or
(ii) the scheme has a trustee who is independent in relation to the scheme for the purposes of section 23 of the 1995 Act (power to appoint independent trustees), or
(b) all the members are directors of a company which is the sole trustee of the scheme, and either
(i) the provisions of the scheme provide that any decisions made by the company in its capacity as trustee are made by the unanimous agreement of all the directors who are members of the scheme, or
(ii) one of the directors of the company is independent in relation to the scheme for the purposes of section 23 of the 1995 Act.
These Regulations also confirm the transitional provisions for loans that were in place for loans made prior to certain dates in accordance with either the Occupational Pension Schemes (Investment of Scheme’s Resources) Regulations 1992 or the Occupational Pension Schemes (Investment) Regulations 1996 – SI 1996/3127.
A registered pension scheme may borrow for any purpose. Borrowing may be from any individual, company or financial institution whether or not they are connected to the scheme, but any borrowing from a connected party which is not made on commercial terms is subject to a tax charge.
Borrowing by the scheme is limited to 50% of the net value of the fund immediately before the borrowing has taken place under a money purchase arrangement. For this purpose scheme assets are defined as the market value of members’ and dependants’ unsecured and alternatively secured pensions and the market value of any non vested benefits. Where a scheme pension or a dependant’s scheme pension is being paid the capital value is determined as 20 times the annual pension payable. It is important to note that there is no separate limit to fund a liability for VAT, for example.
The following example may help to illustrate how the borrowing rules operate. By A-Day Philips John had accumulated a fund of £300,000 with existing borrowing of £75,000. The maximum amount that can be borrowed post A-Day is 50% of his net scheme assets (i.e. in this case £300,000 less the existing borrowing of £75,000 = £225,000). The maximum the scheme can borrow is therefore £112,500, but as borrowing of £75,000 was already in place a maximum of an additional £37,500 can be borrowed.
Where a scheme borrows an amount in excess of the 50% limit, the scheme is treated as making a scheme chargeable payment and is subject to a scheme sanction charge of 40% on the excess amount of the borrowing above the 50% limit.
Where a scheme borrows there is no requirement that this is on a secured basis.
Borrowing which took place before 6 April 2006 was not re-tested at that date. However, it will be taken into account in assessing the 50% limit should further borrowing be required on or after 6 April 2006.
Circumstances can arise where the trustees wish to restructure their existing borrowing, especially where the lender’s rate of interest has become uncompetitive. HMRC has confirmed that where the new borrowing is immediately used to pay off the existing borrowing it will not be treated as an increase in borrowing even though the borrowing is effectively doubled for a short period.
HMRC has also confirmed that when a pension scheme restructures a loan or remortgages and the amount of the loan is not increased, this will not be deemed a new loan even where the term of the loan is being extended and will not be subject to a scheme chargeable payment even if borrowing is now in excess of 50% of net asset value due to falls in investment value. However, where interest due on the original loan had not been repaid it would apply the section 182 test where such outstanding interest forms part of the new borrowing. This will apply even where the aggregate amount of borrowing including the unpaid interest is less than the original loan as highlighted in the following example.
A SIPP took out a £100,000 mortgage on a property prior to A-Day. At first the interest and capital repayments were fully met and the outstanding loan was reduced to £80,000. However, the property became vacant and interest arrears built up during this period so that the loan now stands at £85,000. On re-letting the property the mortgage is moved to a new lender. In this case HMRC has confirmed that as there is £5,000 of outstanding interest on the loan, there will need to be a 50% test under s182.
Where the easement on restructuring does not apply, it is possible to switch from a ‘capital repayment’ basis to ‘interest only’ without retesting provided that the outstanding capital is not increased.
Where a loan is transferred from one pension scheme to another, then as a general rule HMRC would treat this as new borrowing and expect it to be within 50% of net asset value. However, if the new loan is effectively a continuation of the earlier loan agreement (e.g. the loan remains with the same lender and there is no deferred interest) HMRC will consider an exception to the general rule on a case-by-case basis
Any debts between the scheme and the employer or member must be repaid on commercial terms. If not, they are treated as an unauthorised payment.
There are rules to discourage schemes from investing in financial instruments that are designed to remove value from tax-privileged funds to the member, former member, or a connected person, or to a sponsoring employer or former sponsoring employer (ie. value stripping assets). These rules
· provide all investments must be acquired, disposed of or leased on commercial terms
· prevent the use of investments and changes to investments that allow for the value to be taken out of scheme assets
· prevent the use of annuities which provide that certain payments can be made directly or indirectly on the death of members
· provide that all loans to third parties must be on normal commercial terms.
Where value is passed from the scheme to either a member, former member, or a sponsoring employer, the amount of the value shifted out of the scheme is treated as an unauthorised payment if the amount passed is other than what can be expected on arms length terms. A scheme sanction charge is also levied on the scheme.
It is possible to pass value from the scheme without making any payments as such. The following example relating to a change to the rights attached to shares highlights this.
Ewan is a member of the Upton Ltd EPP scheme. The EPP scheme owns 100% of the Class A shares in Upton Ltd, while Ewan owns 100% of the company’s Class B shares.
Both the Class A and Class B shares have similar rights but the Class A shares subsequently have their rights changed so that they no longer provide the right to a dividend.
The result is that value from the Class A shares has passed to the Class B shares and therefore to the member without any payment. Ewan will be subject to an unauthorised member payment charge equivalent to the decrease in value of the shares held by the scheme. The scheme will also suffer a scheme sanction charge.
It is also possible to pass value from a registered scheme through lease transactions as the following example indicates.
The Normanton Ltd SSAS owns a commercial property. The SSAS sells the freehold of the property to Normanton Ltd for a minimal amount subject to a leaseback to the scheme for 100 years and the scheme paying a ground rent of £1 per year. Normanton Ltd subsequently increases the rent to £10,000 per year. Altering the rights to the lease in this way has passed the value of the property from the SSAS to Normanton Ltd.
Normanton Ltd will be subject to an unauthorised payment charge to the value of the decrease in value of the property held by the scheme. The scheme will also suffer a scheme sanction charge.
A further example of value stripping is set out below:
Croft Ltd SSAS owns a commercial property, which is leased to the scheme member, Adrian, subject to a restrictive covenant over its use for a hazardous purpose. The SSAS removes the restrictive covenant, which reduces the value of the asset and Adrian’s liability under the lease. Adrian will be subjected to an unauthorised payment charge to the value of the decrease in the value of the property held by the SSAS. The SSAS will suffer a scheme sanction charge.
The new prohibition on value stripping assets will preclude use of the Open Annuity in its pre A-Day form.
Scheme Assets used by Members
Although residential property and tangible moveable property are now heavily taxed, and would not also be subject to the benefit in kind charge on a personal use of registered scheme assets, the legislation in the Finance Act 2004 regarding the benefit in kind charge has been retained to cover those situations (likely to be very few) where such a charge is appropriate. Its provisions are as follows:-
Where a scheme member, or a member of their family or household has scheme assets provided for personal use, the cash equivalent of the benefit in kind will be charged on the member as an unauthorised payment. This also applies where a scheme has been wound up since the investment was acquired.
For the purposes of the above the following are members of a person’s family:
- the person’s spouse
- the person’s children and their spouses
- the person’s parents, and
- the person’s dependants
The following are members of the person’s household:
- the person’s domestic staff, and
- the person’s guests
Where after the member’s death an asset held by the scheme is used to provide a benefit to a person, who, at the time of the member’s death, was a member of the member’s family or household, an unauthorised payments charge will be made on the person receiving the benefit.
The unauthorised payments charge will not apply where a member is provided with a benefit by reason of their employment, and where that benefit has already been taxed as a benefit in kind.
It should, however, be noted that an unauthorised payments charge will apply in respect of an employee earning less than £8,500 a year in respect of the employment where that individual or someone in their family or household is a director with a material interest (ie. owns 5% of the share capital or has an entitlement to 5% of the assets) in the sponsoring employer, and where the scheme concerned is an occupational pension scheme that is holding the asset providing the benefit.
The basis of the tax charge is set out in Part 3 of the Income Taxes (Earnings & Pensions) Act 2003 (ITEPA 2003).
The cash equivalent of the pension benefit in kind is generally the cost of the benefit to the scheme less any part of that cost made good by the member. However, there are special rules for certain assets (ie. living accommodation or cars and vans and related benefits).
Where the asset provided to the member is not in one of the special cases mentioned in the above paragraph the cost of the benefit to the scheme is the higher of:
- the annual value of the asset. In the case of the use of land (other than living accommodation) this means its annual rental value as defined in section 207 ITEPA 2003. This is the rent that might be expected to be obtained on a commercial letting from year to year if:
- the tenant undertook to pay all taxes, rates and charges usually paid for by the tenant, and
- the landlord undertook to bear the costs of the repairs and insurance and other expenses (if any) necessary for maintaining the land in a state to command the rent.
The annual value of any other asset (ie. except living accommodation, vans, cars or related benefits) is 20% of the market value of the asset (as defined by section 272 Taxation of Chargeable Gains Act 1992 as the price which those assets would reasonably be expected to fetch on a sale in the open market) as at the time the scheme first made the asset available as a pension scheme related benefit.
- the annual amount of the sums, if any, paid by the scheme by way of rent or hire charge for the asset together with the amount of any additional expenses. It should be noted that the following additional expenses are not included:
- the expense of acquiring or producing the asset incurred by the scheme, and
- any rent or hire charge payable for the asset by the scheme which has already been taken into account in calculating the annual value.
Where a member ‘makes good’ the cost of using the asset to the scheme, this amount will be deducted from the unauthorised payments charge. If the scheme allows the member to use an asset and charges a rent, the rental payment will be included in the sums made good.
The ‘taxable property’ provisions set out in section 2 above remove the tax advantages for self-directed pension schemes investing in residential property and tangible moveable assets. However, certain self-directed pension schemes (ie. mainly some SSASs set up pre 1991 and certain s.226 plans) had the ability under the pre A-Day rules to invest in residential property. Transitional protection is extended to these schemes to enable them to continue to hold residential property under the new regime subject to certain restrictions (see section 5). Because such schemes, and other, non self-directed schemes, may continue to both hold residential property under the new regime and provide benefits for members in respect of that property, the legislation relating to member benefits (ie. the benefit in kind tax charge) continues in place.
Living accommodation is accommodation that allows the person to live independently (eg with a bathroom, kitchen, food storage areas as well as a bedroom etc.)
The value of the benefit is the difference between
- the annual value of the accommodation for the taxable period, and
- any sums made good by the member to the scheme
For all UK and overseas properties held by registered schemes, the annual value is the amount of rent that would be payable if the property had been let on the open market under the terms of a commercial lease, in accordance with section 110 ITEPA 2003 (and section 106 ITEPA 2003 for properties over £75,000).
HMRC has issued the Pension Schemes (Co-Ownership of Living Accommodation) Regulations 2006 – SI 2006/133, which set out how to calculate the benefit in kind charge where there is co-ownership of a property between the pension fund and a member or a member of a member’s family or household. The ‘living accommodation benefit’ is apportioned between the scheme (ie. the ‘pension scheme owner’s benefit’) and the member(s) (ie. ‘the private owner’s benefit’). It is the ‘private owner’s benefit’ which will be treated as an unauthorised payment to the member by the registered scheme and which will be subject to a benefit in kind charge.
Car and Van Benefits
Where a car or van is made available to a scheme member, or a member of their family or household, and is available for private use, the member will be taxed on the use of the asset in the same way that an employee would be, if the asset were provided to them by reason of their employment.
The cash equivalent of the car and van benefits are calculated in accordance with Part 3 Chapter 6 of ITEPA 2003. However, there is a difference in relation to car fuel. In the latter case instead of using the scale charges applied to employees, the whole payment for fuel is treated as a cash asset and will be taxed as an unauthorised payment.
Any cash assets, including vouchers, use of credit cards etc made available by the scheme are treated as unauthorised payments taxable on the member.
Where a scheme makes an asset available which is used personally by a scheme member etc, and the asset is a ‘wasting asset’ a scheme sanction charge will be levied on the scheme which is equivalent to the amount of the unauthorised payment to the member. This will be in addition to the unauthorised payments charge on the member. A ‘wasting asset’ is defined in section 44 of the Taxation of Chargeable Gains Act 1992 and is an asset with a predictable life span not exceeding 50 years. Plant or machinery will always be deemed to have a life span of under 50 years. Therefore all cars (even veteran or classic cars) are ‘wasting assets’.