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Using commercial property within self-invested pensions

Michael Hulse, Wealth Management consultant at Mattioli Woods looks at the issues and practical considerations involved

One of the many advantages of self-invested pensions, whether those be small self-administered schemes (SSASs) or self-invested personal pensions (SIPPs), is the ability for members to self-direct the investment strategy.

For many owner-managed and family business owners, such flexibility allows them to use their pension as a business tool to grow and develop their business by investing in assets over which they have control, rather than third-party investments such as stocks and shares. 

One such investment is through the acquisition of commercial property, which I will look at now in further detail, including some of the practical considerations.

HMRC rules 

Although HMRC does not specifically ban any type of property, it has introduced regulations that impose tax charges on pension schemes investing in certain types of property. 

Acceptable properties must be commercial and can be purchased freehold or leasehold. The properties can be UK or overseas based; however, overseas properties can involve additional complexities. Some countries – France, for example – do not recognise trusts. Typical examples of accepted properties include offices, industrial/business units and warehouses, and shops.

Residential property is generally not permitted other than in exceptional circumstances, i.e. job-related residential accommodation. The main unacceptable properties that will give rise to a tax charge are direct purchases of residential property, including holiday lets, beach huts and student flats/houses.

And finally, for the avoidance of doubt, the pension scheme cannot buy fixtures, fittings or business goodwill, only the land and fabric of the building.

The process

Before any property purchase takes place, the potential purchaser will need to complete a property purchase questionnaire for their self-invested pension provider. This typically sets out the basic details of the purchase and allows the administrator to identity any potential issues.

Timescale

The purchase of any property, whether commercial or residential, can come up against unexpected complications. In our experience, it can take 8 to 12 weeks from instruction of solicitors to completion. It is essential a) the pension scheme making the acquisition be established well before the purchase process commences and b) it is clear where the funding or financing will come from. 

Cost

In addition to the acquisition cost of the property itself, there are many other costs to consider that are often overlooked, such as:

• solicitor’s fees

• land registry fees

• valuation fees

• stamp duty 

• VAT

• lender’s fees 

• surveys

All costs in relation to the purchase can be borne by the scheme. Depending on the flexibility of the provider, it may be possible for the property to be acquired jointly between the pension scheme and a third party, in which case costs will be apportioned. 

Property development 

Commercial property, once owned by a pension, can be refurbished or developed with the caveat that no residential element is added (beyond the point of habitation). Land can also be developed as commercial property without any tax consequences. 

Where the pension scheme owns the property outright, all costs should be settled directly from the scheme. It is possible for the work to be carried out by a connected party, for example a building firm developing their own building, but quotes must be provided to ensure any invoices are being raised on a commercial arm’s length basis. Care should be taken in such circumstances to ensure the business isn’t seen as seeking to trade via the pension scheme. 

Professional services

While at first glance the pension scheme investing in an asset would be a matter for the member and professional trustees, there are additional parties to consider with property acquisition. 

Surveyor:  The property to be purchased needs to be independently valued by a registered member of the Royal Institute of Chartered Surveyors (RICS). 

Lender:Borrowings can be made from any source, not just a bank, which does mean that part or all of the borrowing can be made from the company or indeed the member, providing that this is on commercial terms.  

Solicitor: With any property transaction there is a considerable amount of legal work to be undertaken, and a solicitor would be appointed on behalf of the scheme trustees. Each provider will also want the relevant liabilities and clauses included, so it is essential a solicitor with the appropriate skills and qualifications be engaged.

The legal owner: Once a property is acquired, the legal owners of the property will become the trustees of the pension scheme. The property would no longer be owned by the member personally or by their business.  

Valuations

A formal valuation and surveyor’s report will be required for all connected party transactions. This must be addressed to the trustees of the pension scheme as they will be the beneficial owners. The report must normally specify:

• market value

• rental value if there is a new tenant 

• rebuilding / reinstatement valuation for insurance purposes 

• whether any further structural survey is recommended

As a pension scheme asset, it is important for members to understand that in order, for example, to draw benefits, or in the event of a member death, the pension scheme would need to be valued. In respect of a property, this is a clearly more onerous and expensive requirement than it would be for say a simple unit trust. 

Borrowings

In line with HMRC regulations, a SIPP or SSAS can borrow funds to assist in the purchase of scheme investments. This can be a valuable benefit when looking to acquire commercial premises, but if borrowing is used to complete the acquisition, it should be in place well before the acquisition to ensure funds are available. 

HMRC restricts borrowing to a maximum of 50% of the scheme’s net value. This limit includes any existing borrowings and any amount borrowed to finance VAT on the purchase. Any loan offers and subsequent borrowings must be in the name of the trustees and funding agreed and in place prior to exchange of contracts. For investment reasons, one must ensure the rental income from the property is more than sufficient to meet the repayments and any other associated costs. 

Tenants

Depending on the individual situation, the property may be leased to a connected party (owner’s own business) but could also be leased to an unconnected third party. If the former, then the lease must be on a fully commercial arm’s length basis as assessed by a RICS chartered surveyor. Where the landlord and tenant are connected and rent is not paid in accordance with the terms of the lease, this may be deemed to be an unauthorised payment with significant HMRC tax charges. 

Lease

Any rent received in relation to the property must from the point of acquisition be credited to the scheme’s bank account. If the property transaction is connected, the tenant cannot pay rent above or below the market value, e.g. just to cover the mortgage. This is because it would not be classed as a commercial arm’s length transaction. 

Insurance

Buildings insurance cover must be in place, which includes public liability insurance on land without buildings. Some providers offer a bloc insurance policy of pension fund property, which can attract favourable rates and provides comprehensive specialist cover. 

VAT

Commercial property can either be exempt from VAT, or ‘opted to tax’. When opted for tax VAT is chargeable on the sale or rental of the commercial property, it is possible for the trustees of the pension scheme to register for VAT and reclaim the VAT charged on the purchase price. However, there will be a delay between the acquisition and VAT being reclaimed. This discovery late on in due diligence can scupper many a transaction, as the cost can easily be forgotten or misunderstood in terms of the time it takes to reclaim.  It is worth checking if the property could be purchase as a ‘transfer of a going concern’. This is important as stamp duty will be charged on the purchase price including VAT.

Key benefits

There are many advantages to using pension scheme funds to purchase a commercial fund property, such as: 

• giving the business owner the ability to self-direct an investment strategy

• tax relief being received on contributions, which can be used towards the purchase of the property 

• the scheme borrowing up to 50% of the scheme’s net value to assist towards acquisition

• rental income being received gross and free from income tax

• any gains on the property being free from capital gains tax

• the property being held out of the member’s estate for inheritance tax purposes

Focus on the end game

As you can see, there are many benefits to acquiring commercial property via a pension scheme, but the process can be complicated and requires specialist knowledge and expertise. From a planning perspective, it should not be forgotten that whatever a pension scheme can do by way of investments, the primary purpose is to provide an income stream in retirement.

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