Martin Tilley: SSAS as an alternate lender

Martin Tilley looks at the world of SSAS pension-led funding including what makes a suitable security to protect a scheme against loss - and it's not Rolex watches, classic cars or diamonds...

Although as far as economic cycles go, we have seen far worse, advisers looking for alternative sources of finance for their corporate clients often approach us.

The ability to borrow from, and therefore repay interest to a connected party rather than into the coffers of a large bank is appealing. The ability to deal quickly with the connected pension scheme trustees as opposed to faceless bank acceptance committees is also cited.

This particular alternative finance source is sometimes known as pension-led funding.

It involves the borrowing of funds from an existing small self-administered scheme (SSAS).

These schemes particularly serve the SME marketplace well and lend themselves to owner-operated businesses. The scheme members will often be the company’s directors and shareholders and effectively they are lending from one pocket of their own wealth to another in a tax efficient manner.

The SSAS receives the interest free of income tax, while the company can make use of pension scheme capital.

As you would expect, HM Revenue & Customs (HMRC) has a strict set of requirements to ensure that arm’s length terms are in place and that the SSAS funds, which have benefited from tax relief when contributed, are protected from loss.

Essentially the loan must meet the following criteria:

  • Be less than 50% of the scheme’s net assets
  • Be repayable by capital and interest repayments
  • Have a maximum term of five years
  • Have a commercial rate of interest
  • Be secured with a first charge

It is the first legal charge that provides the protection against loss of scheme assets and this is often an obstacle. Everyone understands the reasoning behind HMRC’s requirements and the scheme’s trustees’ should obviously be acting in the interests of all the scheme’s beneficiaries but the ramifications of holding certain assets as security are not always understood.

Provided the loan is serviced and repaid in accordance with the written loan agreement, the security issue becomes moot.

However, it is in the event of a default that requires the security to be called upon, where an issue can occur. It is at this point that the scheme’s trustees have a financial interest in the asset held as security.

If this asset is a commercial property, there are no adverse implications as a registered pension scheme can seize the property and hold it as its own until disposed of without concern, as commercial property is most usually an acceptable and non-taxable asset.

However, we are often offered assets that are more unusual as security for a company loan. These have included Rolex watches, classic cars, a yacht and diamonds to name but a few of the more esoteric. Lorries and other plant and machinery are more common.

However, all share the same problematic feature: they are taxable movable property and the moment that the trustees exercise their right to the security, they hold an interest in that asset.

This immediately triggers a succession of tax charges including an unauthorised member payment tax charge equal to 40% of the value of the interest acquired, a scheme sanction charge equal to 15% of the interest and if the interest is valued at more than 25% of the scheme’s total asset value, a further surcharge of another 15%.

In addition, at the point the legal charge is created, the borrower must settle the costs associated with this and not the scheme as the costs themselves could be regarded by HMRC as arranging for a financial interest in taxable property being put in place.

The tax charges are likely to impair the ability of the scheme to receive full value of the loan capital and interest, an outcome that is obviously not in the best interests of the scheme’s beneficiaries.

The “all members are trustees” caveat is not effective, as while the member trustees might have been complicit in their acceptance of the security and therefore in control of their own losses, the list of beneficiaries could well extend beyond the scheme’s immediate membership and might include spouses and children.

Simply meeting the security requirement of loans is therefore only the first step in accepting a loan as a proposed investment of a scheme.

Martin Tilley is director of technical services at Dentons Pension Management