Tech Talk. Esoteric investments

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1 ADVISER FACTSHEET Tech Talk December 2012 Esoteric investments This Tech Talk is the second in a series covering specific issues surrounding the three stages of retirement planning through a registered pension scheme. The previous Tech Talk dealt with the subject of in-specie contributions and consideration is now given to investments within those pension arrangements that offer most choice i.e. Self Invested Personal Pensions (SIPP) and Small Self Administered Pension Schemes (SSAS). The final Tech Talk in the series, to be published at a later date, will focus on the extraction of income at retirement. Features Introduction Unquoted shares Third party loans Wind turbines and solar panels Intellectual property Comment For professional advisers only 1

2 Introduction Many SIPP and SSAS providers take on the responsibilities of trustee and scheme administrator and these additional responsibilities, together with any regulatory obligations, influence the choice of investments available under their schemes. As trustees they have a duty to act in the best interest of the members and therefore it would be hard to justify any type of taxable property as an allowable investment due to the adverse impact the associated tax charges have on the pension fund; not to mention the additional reporting that this would create for scheme administrators. Ignoring any taxable property considerations, esoteric investments usually mean more work for scheme administrators, often with manual workarounds etc. and a resultant pressure on administration costs. These fiduciary and commercial considerations may not be of interest to advisers and their clients, but nevertheless are worth mentioning in terms of the impact on investment choice. Faced with challenging investment conditions some investors turn their attention to esoteric investments as a way of maximising investment return on their pension fund. Bearing in mind that these investments tend to carry more risk, their suitability as a pension investment deserves careful scrutiny by advisers and their clients. There is no strict definition of what is meant by esoteric investments and what follows is a brief look at particular investments with a view to highlighting important issues from an advice perspective. The list of investments considered below reflects the enquiries received by the TSU and is by no means exhaustive. This Tech Talk gives generic guidance on certain investments available through SIPP and SSAS. It is not to be read as a definitive guide to the investments allowed by the James Hay Partnership in connection with any of their pension products. For information on the investment opportunities within the James Hay Partnership product range please visit the website literature/index.aspx or alternatively please contact your local James Hay Business Development Manager. Unquoted shares There is nothing in legislation that prevents a SIPP or SSAS holding unquoted shares. In the case of a SSAS, as an occupational pension scheme (OPS), there is a restriction in the amount of the scheme assets that can be used in the purchase of the shares where the shares are those of the sponsoring employer. At the time of purchase the value of the shares must be less than 5% of the net asset value of the scheme. If the SSAS has more than one sponsoring employer, the 5% limit applies to each sponsoring employer individually, subject to an overall maximum of less than 20% in all sponsoring employers. Where the 5% or 20% limits are exceeded the amount invested will be treated as an unauthorised employer payment and suffer the tax charges associated with such a payment. This particular issue is not relevant for SIPP as there is no sponsoring employer regardless of whether any employer contributions are being made in respect of the members. Another potential barrier to the holding of unquoted shares is the indirect holding of taxable property. Both SIPP and SSAS are classed as investment regulated pension schemes and where such schemes hold taxable property, directly or indirectly, tax charges result. Indirect holding occurs where a scheme holds an interest in a vehicle, which in turns owns taxable property or holds an interest in another vehicle that owns taxable property. Not all indirect holdings of taxable property give rise to tax charges. Provided the vehicle that owns the taxable property meets the definition of a genuinely diverse commercial vehicle no tax charges apply. Interest in a vehicle includes the holding of shares. 2

3 The registered pension scheme manual (RPSM) categorises genuinely diverse commercial vehicles under three headings: UK Real Estate Investment Trusts (UK REITS) RPSM Trading concerns RPSM Other kinds of vehicle RPSM The conditions that need to be satisfied for a particular vehicle to be considered a genuinely diverse commercial vehicle are set out in the RPSM pages referenced above. Where, for example, the vehicle is a trading company the conditions are as follows: The vehicles main activity is the carrying on of a trade, profession or vocation. The pension scheme, if it is an occupational pension scheme, either alone or together with associated persons does not have control of the vehicle or, where the pension scheme is not an occupational pension scheme, an arrangement under the scheme either alone or together with associated persons does not have control of the vehicle. The second part of this condition means that the condition will be met where say a non occupational pension scheme held 51% of the voting shares of a company but in respect of 51 different arrangements under the scheme for unconnected members and 1% of the shares are held by each arrangement. Neither a pension scheme member nor a person connected to such a member is a controlling director (broadly 20% controlling director) of the vehicle or any other vehicle which holds an interest in the vehicle directly or indirectly. Where the pension scheme is not an occupational pension scheme as explained above this test applies at arrangement level rather than at scheme level, so if in the example above a member of an arrangement does not meet this condition, tax charges will apply. But if this condition along with the other 3 conditions are met in relation to the other 50 arrangements under the scheme, then the indirect holdings held by those arrangements will not be subject to tax charges. The pension scheme does not directly or indirectly hold an interest in the vehicle for the purposes of enabling a pension scheme member or a connected person of such a member to occupy or use the property. As can be seen from the above, for a trading company the identity of shareholders and their respective shareholdings are important in determining whether the company is a genuinely diverse commercial vehicle. It is possible that even where the company falls foul of these conditions it may not own any taxable property and therefore no tax charges would arise. However, given that the definition of taxable property includes tangible moveable property (i.e. things that can be touched and moved) monitoring a company to ensure it doesn t hold such property would be an onerous task and because of this many SIPP/SSAS providers will not sanction the holding of shares in companies that do not meet the genuinely diverse commercial vehicle criteria. The definition of associated persons can be found in the relevant page of RPSM, as well as that of control which is briefly touched on in the next section. Third party loans RPSM confirms that any loan made by a registered pension scheme to a person who is, or has been, a scheme member or person/company connected with the person who is, or has been, a scheme member or sponsoring employer will result in an unauthorised payment equal to the amount of the loan. However, these charges do not apply where authorised employer loans are made by OPS to sponsoring employers. For completeness it is worth mentioning that DWP legislation restricts the level of employer related investments that OPS can make, and loans are covered by this restriction. Fortunately, SSAS with fewer than 12 members, all members being trustees, and trustee decisions being made on a unanimous basis, are exempt from this restriction. This exemption means that SSAS, provided certain 3

4 conditions are met, can loan up to 50% of the net asset value of the scheme to sponsoring employers. Authorised employer loans aside, whether an individual or company is connected to a scheme member or sponsoring employer will be crucial if consideration is to be given to permitting such a loan under either a SIPP or SSAS. Connection is determined in accordance with s993 and s994, ITA2007. An individual is connected to the member if he/she is one of the following: Spouse or civil partner of the member, Relative of the member, Spouse or civil partner of a relative of the member, Relative of the member s spouse or civil partner, and Spouse or civil partner of a relative of the member s spouse or civil partner. Relative in this context means brother, sister, ancestor or lineal descendant. Using the above it can be seen that while the member s children, the member s spouse s children from a former marriage are classed as connected, the member s brother s children i.e. nieces and nephews are not. For a company to be connected to the member, the member either alone or together with connected persons has/have control of the company. For example if the member owned 1% of the share capital in Company A and the member s sister owned a further 50%, Company A would be connected to the member. Legislation places no limit on the amount that a SIPP or SSAS can loan to an unconnected third party. HMRC expectation is that such a loan must be a genuine investment of the pension scheme and should be prudent, secure and on a commercial basis. Strangely, this expectation is not backed up with any definitive legislation as is the case with authorised employer loans. Note that where a pension scheme provides a guarantee in connection with a loan the scheme is treated as having loaned an amount up to the level of guarantee. Also any debt created by a scheme selling an asset that does not require immediate payment could, in certain circumstances, also be treated as a loan from the scheme. Where the other party involved in the transaction is a scheme member, sponsoring employer (in case of a SSAS), or connected to either, then provided the debt is repaid on an arms length basis no loan is deemed to have occurred. Wind turbines and solar panels The issue with both is whether the structures fall within the definition of tangible moveable property and therefore classed as taxable property. HMRC guidance confirms that there is no blanket classification for either, and so classification is determined on a case by case basis. Scheme providers and advisers like to deal with certainties and it comes as no surprise that this uncertainty presents both with a problem. For many providers the easy way to remove the uncertainty is to say no to all such structures. Unfortunately, advisers cannot dodge the issue, and where clients are keen to pursue this type of investment through their pension arrangement, they must be aware of HMRC thinking and be able to communicate this to their clients. Dealing with wind turbines first, what is the current view of HMRC? What follows is based on the correspondence the James Hay Partnership has seen from HMRC on the subject. A substantial stand alone structure as seen on a wind farm would be unlikely to be treated as tangible moveable property. Whereas a turbine attached to a house or a light weight rotating blade on top of a mast would be likely to trigger the charges associated with taxable property as being residential or tangible moveable property. The size of the asset is not itself a determining factor. However, if the wind turbine is large and is as a matter of law fixed to the ground so as to become part of the land interest then it will not fall within the definition of tangible moveable property. If the scheme owns the land on which a large wind turbine is fixed, for what reason has the acquisition been made? Is the electricity being 4

5 generated by the wind turbine being sold? If so the scheme may be deemed to be trading. Income derived from trading is not investment income and therefore does not benefit from the tax breaks associated with such income. So the scheme would be liable for tax on trading income meaning that the trustees of the scheme would need to submit a self-assessment tax return. In the case of solar panels where these are an integral part of the building and the pension scheme purchased the building and in doing so the solar panels as well, current HMRC guidance is that the panels would not be treated as tangible moveable property. If any electricity generated by the panels ends up being sold then scheme trading, and all that that entails, becomes an issue. An idea circulating as a way of avoiding this is for the pension scheme to rent out roof space for a company to install solar panels. The theory being that the trading of electricity would be done by the company, not the pension scheme, and in addition the rental income would be treated as tax efficient investment income of the pension scheme. Feedback on this idea is not widely available, and as a note of caution for advisers it is worth running the idea by SIPP/SSAS providers first as there are a number of obstacles, not least any potential tax implications, to be negotiated before taking clients down this route. Intellectual property The Intellectual Property Office (IPO) is the official government body responsible for granting intellectual property (IP) rights in the United Kingdom. There are four main types of IP rights: patents, trade marks, designs and copyright. As IP can be owned, bought and sold, this opens up the possibility for it to be held as an asset under a pension scheme. IP is intangible and therefore is not classed as taxable property. Whether IP will be allowed under SIPP or SSAS is likely to be determined by how easy it is to establish ownership and value it. An independent valuation will be required in the event of both purchase and sale and the cost of such valuations will be met by the scheme. 5

6 Comment Advisers with clients looking at SIPP or SSAS as their preferred pension vehicle will be confronted by marketing literature from providers highlighting the investment opportunities that exist. Understanding the risks that come with a particular investment is crucial for both advisers and clients, and this Tech Talk offers insight on the risks associated with the investments covered under the preceding headings from the viewpoint of current pension tax legislation. As hinted at above SIPP/SSAS providers have in addition to pension tax legislation other considerations to take account of before agreeing to a particular investment being held under their schemes. These additional considerations are outside the scope of this Tech Talk. Please note, as previously mentioned, that referencing a particular investment should not be construed as an endorsement of it from the James Hay Partnership. Whereas the range of investments available under SIPP/SSAS is the domain of the providers, the suitability of investments is a matter for clients and their advisers. This bulletin is therefore offered to advisers merely as a potential source of reference and not for tackling the question of suitability. John Dunn Pension Specialist Technical Support Unit Further information Please do not hesitate to contact the Technical Support Unit with any further queries on: Pensions Technical Support: pensions.techsupport@jameshay.co.uk Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue Customs practice are subject to change. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at IFG House, 15 Union Street, St Helier, Jersey, JE1 1FG. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL and UPT have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. UPTL has its registered office at Boundary House, Charterhouse Street, London, EC1M 6HR. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Services Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FSA. Therefore, IPS and IPS Plc are not regulated by the FSA in relation to these schemes or services.(10/12) JHSTT 01 DEC12 GDF