January 2008

Navigating the SIPP maze

Since pension A-Day some 20 months ago, the title "pension simplification" seems to have been quietly dropped. Pensions, if anything, seem to have become more complicated. Certainly on the investment side debate still rages over what can and can't be held as a pension fund asset. Furthermore, after Gordon Brown's infamous u-turn in December 2005, some investment firms are only now gingerly dipping their toes back into the SIPP waters. It is worthwhile having another look at this issue to see if some questions can be answered.

Taxable property

A-Day introduced a new concept known as "taxable property" - basically meaning residential property and tangible moveable property. Residential means anything that can be deemed a dwelling, including gardens and grounds. Tangible moveable property means just that, and includes art, antiques, wine, stamps, jewellery, vintage cars, yachts etc. These are of course the new asset classes which generated so much interest prior to A-Day.

Unfortunately, the new regulations introduced extremely heavy tax penalties for anyone investing in taxable property via their pension fund, either directly or indirectly (i.e. via a private company where the pension fund owns shares). These tax penalties are summarised in the table (see page 17).

However, there are three ways of investing in taxable property via a pension fund which do not incur these tax penalties.

- The first is REITs (real estate investment trusts), quoted companies and is therefore something of a red herring. Although taxable property investment could feasibly occur with a quoted company it is highly unlikely because of the company's size, and because of the trading concern rule explained below.

- The second is another new concept known as "genuinely diverse commercial vehicles" (GDCVs). These are basically pooled funds such as exempt property unit trusts, and OEICs. Although the Revenue does not restrict the legal structure, an unquoted company could qualify. A GDCV must match certain criteria laid out by the Revenue:

(a) No pension scheme member (or connected party) can hold more than 10% of the vehicle.

(b) The total fund must be at least £1,000,000 or there must be at least three assets, none of which exceeds 40% of the total vehicle's value.

(c) No scheme member must be permitted to occupy or use taxable property held by the vehicle.

(d) If it is an unquoted company, it must not be a "closed company" (i.e. controlled by five or fewer individuals).

Provided these criteria are met, the GDCV can invest in anything, including art, antiques, wine, stamps etc., as well as residential property. A number of these funds, particularly in the property arena already exist and more are being launched all the time.

- The third is "trading concerns", which essentially means unquoted companies. Pension funds are permitted to purchase shares in unquoted companies that hold any type of asset, provided another set of criteria are met. These are that:

- The company must be a trading company, not an investment company.

- The pension scheme (and connected parties) must not control the company (own 51% or more of the shares).

- No pension scheme member (or connected person) can be a controlling director (an owner director who owns 20% or more of the shares).

- The ownership of the shares by the pension scheme must not allow a pension scheme member or connected person to occupy or use taxable property.

This allows employees and minor shareholders (up to 20% combined holding personally and via their pension funds) to purchase unquoted shares in the company they work for. There are also no restrictions on owning shares in unconnected unquoted trading companies (other than the restriction on using taxable property). Owner directors are however caught by these rules and even if their company does not invest in taxable property per se, such as a house builder, they will be prevented by the "low value taxable property" rules, where the investment will be taxable if they use the company's every day equipment - telephones, computers, chairs, desks etc.

Property

Direct property investment in commercial property has been permitted by pension schemes for many years and this has not changed. There has however been some clarification on what constitutes commercial property, which has produced some new opportunities. These include:

- Hotels, including ownership of part or all a hotel, provided no part is occupied by a member or connected person, or they have a right to occupy a part. From this has sprung the "Guestinvest" concept for pension schemes, where a pension scheme can purchase a hotel room and participate in the room rent received. The hotel is operated by a hotel management company and the room rent is divided between the company and the room owner. The scheme member and their family are not, of course permitted to occupy the room.

- Student accommodation (a hall of residence but not flats or houses).

- Care homes or prisons.

- Purchase of land and development of residential property, or conversion of a building to residential, provided the pension scheme disposes of the property before the development or conversion is complete (e.g. in the UK when the certificate of habitation is issued). This means the property must be sold before it becomes habitable. In these cases there is a risk that the transaction will be classified as trading, and have the profit taxed accordingly. The Revenue's badges of trade are explained on the HMRC website, and anyone considering this route must be satisfied they are not going to be trading before they proceed.

- The residential element of a commercial property provided it is not occupied by a pension scheme member or a connected person. For example, a flat above a shop, where the shop and flat are let to the shopkeeper. The implication is that the shopkeeper must be in residence at the point of purchase, and if they leave and are not replaced simultaneously by another, then the property becomes taxable immediately. Clearly, this is a very high risk approach.

- Residential elements of a commercial property which are occupied by an employee as a condition of his or her employment (provided the employee is not a member of the pension scheme or a connected person). If the occupant changes and is no longer resident as a condition of employment, the property automatically becomes a taxable property. A pub with a manager's flat above would fit into this category.

Gold bullion

Investment grade gold bullion is another new investment opportunity not previously allowed. The Revenue has set out its definition of "investment grade", which is a common term within the bullion industry. For this to work with a pension scheme, an account needs to be opened by the pension fund with a bullion dealer who offers storage via their own vaults. As long as this method is used, it offers an interesting new investment opportunity.

Hedge funds, derivatives and contracts for difference

Once again, these have been investment options for pension schemes for many years, but are sometimes overlooked. In times of volatile stock markets these investments can be attractive. Derivatives and CFDs can be accessed by opening an account for a pension scheme with a stockbroker and there are many to choose from. As for hedge funds, the market is huge and although perhaps daunting, the sector is becoming increasingly well understood and opportunities are numerous.

Intellectual property

Under A-Day rules, this has become an allowable asset class, as it is neither tangible nor moveable. Considerable interest has been generated here. However, there are two practical problems involved with this:

- Firstly, valuation. In many cases, the intellectual property in question is of a connected nature and is owned by the pension scheme members' businesses or themselves personally. For a pension scheme to acquire intellectual property it must be valued independently which is often difficult to do. There are a number of experts who specialise in this field, but the cost can be prohibitive.

- The second issue is how the ownership of the intellectual property is recorded. The Intellectual Property Office is the Government body responsible for keeping a record of who owns what and standard forms are available to re-register ownership. However, they do not handle copyrights.

As this is a very specialist area it is advisable to employ the services of an intellectual property attorney such as a member of the Chartered Institute of Patent Attorneys. Once again cost may be prohibitive.

In summary, following A-Day the investment opportunities available to UK pension schemes have indeed widened considerably, although there are complex criteria to navigate to ensure the line is not crossed into the taxable property danger zone. Expect to see ever more creative and interesting schemes in the offing, but of course the warning must always be that these may not be appropriate for everyone. We are talking about people's retirement savings after all.

- Richard Mattison is business development director at The Pal Partnership

POSSIBLE TAX PENALTIES

Acquisition

- Unauthorised payment charge 40% of the amount invested payable by the scheme member(s)

- Scheme sanction charge 15% of the amount invested payable by the pension fund

- Unauthorised payment surcharge (only if the amount invested exceeds 25% of the total fund) of 15% of the amount invested payable by the scheme member(s)

Annual charge

- Scheme sanction charge of 40% of the income derived from the investment, payable by the pension fund

- If income is less than 10% p.a. it is deemed to be 10% for the purposes of the tax charge

Disposal

- Scheme sanction charge of 40% of the gain, calculated in the same way as for capital gains tax (i.e. no taper relief from April 2008), payable by the pension fund.

Richard Mattison
Business Development Director
IPS Partnership