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Commercial property – options around funding

Stephen McPhillips, technical sales director, Dentons Pension Management looks at ways for a business to fund the purchase of a commercial property for its use and where the right SIPP provider may prove useful

Many businesses require commercial property premises to trade from – be these offices, industrial units, warehouses, shop units and so on. Consequently, the commercial property market appears to be quite buoyant, despite continued political and economic uncertainty. Indeed, in some geographical areas of the UK, advisers report that clients (and indeed the advisers themselves) can struggle to secure suitable premises for their businesses.

When clients do locate a property that is suitable for their business needs, thoughts naturally turn to how the purchase is going to be funded. Fortunately, there is a wide range of options open to clients, some of which are discussed in this article.

Client’s business funds the acquisition itself

Perhaps seen by some as the most straightforward route to adopt, this option involves the business using cash to make the purchase. That cash may come from existing cash resources within the business and / or borrowing from a commercial lender or a connected party (e.g. the director(s) of the business if it is an incorporated entity). In practice, it is likely to involve a combination of existing cash (as a deposit) and borrowing. If a commercial lender is involved, it is likely to take a legal charge over the property to secure the lending and it will have regard to the borrower’s ability to make the capital and interest repayments in determining whether to lend the required funds. 

Once the property is acquired, the client’s business can take up occupation and trade from the property. No lease would be required and no rent would need to be paid because the business owns the premises from which it trades. The client’s business is free to choose when to dispose of the property and the eventual sale proceeds could be liable to a Capital Gains Tax / Corporation Tax charge, depending on the extent of any gain made on the value of the property.

The property is held as an asset of the business, with the attendant considerations around cashflow, failure of the business, creditor accessibility to the assets of the business and so on.

Client personally funds the acquisition

This is less common and may involve the client personally borrowing funds to assist with the purchase.

Typically, the property would be leased to the client’s business and the client would receive rental income from it to boost his / her annual income stream. Of course, if the client has borrowed funds to assist with the purchase, capital and interest repayments are likely to be met fully, or in part, from the rental income received. The rent paid by the business should be a tax-deductible business expense.

The client is free to choose when to dispose of the property and the eventual sale proceeds could be liable to a Capital Gains Tax charge.

The property is held as an asset of the individual client, with the attendant tax considerations around personal wealth and assets owned.

Client’s self invested pension scheme funds the acquisition

This is a very popular route for clients to adopt – particularly in the case of owner / managed businesses. Once again, there may be a combination of existing cash and borrowing involved. In this case, the cash is pension cash and the pension scheme is the borrower. The lender can be a commercial lender or a connected party (such as the client / the client’s business), provided that the transaction takes place on demonstrably commercial terms where the lender is indeed a connected party.

The pension scheme leases the property to the business which occupies it (the tenant). If this tenant is the client’s business (or any other connected party), then a Registered Valuer (of the Royal Institution of Chartered Surveyors – RICS) should confirm the open market rental value of the property to ensure that a commercial level of rent is received by the pension scheme. If the tenant is an unconnected party, a rental valuation is not necessary, although both parties (the pension scheme as landlord and the tenant) might wish to obtain one in any case to satisfy themselves that the rent is a fair one and comparable with similar properties in the locality.

The rent paid by the tenant should be a tax-deductible business expense. It is received tax-free into the pension scheme bank account and available to be invested and / or to service any pension scheme borrowing.

The client should be free to choose when the pension scheme disposes of the property. The eventual sale proceeds should be free of Capital Gains Tax.

The property is held as an asset of the pension scheme, with the attendant tax advantages, which apply to UK Registered Pension Schemes generally. It is legally ring-fenced from the client’s personal and business assets and there may be substantial benefits relating to Inheritance Tax savings on the death of the client. 

Combinations of the above funding options

Depending on the selection of the self invested pension scheme provider, it may be possible to combine some or all of the above options.

While a combination of any of these options may seem overly complex, it is sometimes the only way in which a client can fund the acquisition of a property that meets their needs. This might be because no one entity can fully afford the purchase and it is only through a combination of options that a solution exists.

It should also be borne in mind that any lender involved in joint purchase of property will have its own requirements around the parties to which it is lending and the security which it can take.

With the right combination of scheme provider and lender, numerous potential solutions open up to advisers for their clients.  

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