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Trust in the pension transfer

What constitutes a recognised pension transfer? Gareth James, head of technical at AJ Bell looks at a recent court case where this became the focus of attention

The liberation of funds from pensions using means that HMRC or the FCA have taken issue with has taken a number of forms over the years.  

Since the pension freedoms an area of significant concern has been the withdrawal of funds from pensions, legitimately at the point they leave the scheme, with the intent of being placed in sham investments outside the scheme.  

Prior to the pension freedoms, models tended to focus on transfers to schemes which met the basic requirements to qualify as a HMRC registered pension scheme, but under which members were allowed to make investments or withdrawals in a manner that wasn’t consistent with HMRC’s rules.

These sort of model would not be of concern to the vast majority of financial advisers, who would take care not to become involved in transactions of this nature.

However a case which has recently reached the Court of Appeal has highlighted an issue which is worthy of consideration.

It involved a situation where a scheme member looked to move their funds out of a legitimate SIPP into a pension scheme with the intention of investing, through a complex structure involving a number of vehicles that were under their control, in residential property.

Since 2006, HMRC has imposed strict controls on pension scheme investment in residential property, with heavy tax penalties being imposed should those controls be breached.  

In this case, HMRC initially believed that the complex investment structure used under the receiving pension scheme breached these rules.  As such it attempted to impose tax charges linked to that investment.

However, as the investigations and legal proceedings progressed, attention moved from a focus on whether the investments met HMRC requirements, to whether or not the transfer from the legitimate SIPP to the new pension scheme qualified as a recognised transfer.

This was because questions were raised as to whether the receiving scheme was a valid trust.  If this was found not to be the case then the receiving scheme would not qualify as a registered pension scheme, meaning the transfer itself would be an unauthorised payment.

When creating a trust, three certainties must be present in order for the trust to be valid:

  1. Words/intention – there must be clear intention to create a trust
  2. Subject matter – the assets subject to the trust and the beneficiary’s share of those assets must be certain
  3. Objects – the beneficiaries must be certain 

When this case was originally considered by the First Tier Tribunal, it was found that the wording of the trust deed was not clear in respect of what benefits the members would be entitled to. As a result, the trust failed the certainty test, so the trust was considered void. 

In the final decision, the judge’s comments recognised that everyone involved at the time, including the administrator of the transferring scheme, did not know that the receiving scheme (which let’s remember was registered with HMRC) was not a valid pension scheme. 

The decision does not appear to imply that any parties involved are expected to identify whether a trust is valid or void at the point of transfer.  

If that became a requirement it would create interesting implications for the process and timing of transfers between many schemes.  

The problem wording identified was linked to limits on the benefits that were available under the scheme.  Reference was made to a section of legislation which didn’t set out any method used to calculate benefit entitlement, making it unclear how this would be done for scheme members.  Hence the failure of the certainty test.

The court decision mentions that “materially identical” wording had been used in the trust deeds of pension liberation schemes.  This could be considered potentially useful in giving firms an indication on what to watch for as a possible ‘red flag’ when carrying out own due diligence on transfer requests, but that would be reliant on those red flags being well known and easily identifiable.

The case confirms a position where, regardless of the legitimacy of the activity undertaken within the receiving scheme, if the scheme itself isn’t structured correctly, what might appear to be a perfectly standard transfer could create tax implications.

Whilst it would be expected that transfers between well-known schemes/providers would be green-lighted as a matter of course, if an expectation were created that administrators (or advisers?) involved in transfers to smaller, or newer, administration firms needed to establish that the underlying trust was valid, potentially taking specialist legal advice to do so, the cost and time implications on transfers would not be good.

I’m not expecting this case to create expensive requirements to check the validity of trust documentation but it presents an additional reason to exercise care and discretion if any concerns about proposed activity are held.

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