A recent court ruling has left investors who have made in specie contributions of shares, property or any other permitted asset other than cash to their pension plan facing the prospect of hefty tax penalties. For many years, in specie contributions were accepted by HM Revenue & Customs (HMRC) and self-invested personal pension (Sipp) providers as legitimate investments that qualified for full tax relief. However, HMRC has now won a legal battle to only give cash contributions tax relief. It may look to recoup millions in tax relief given to investors on in specie contributions, although some lawyers believe that it will struggle to do this, as its own manual gave incorrect guidance.
This case is a reminder of the importance of staying within Sipp rules to avoid penalties. Even inadvertent rule breaches can lead to tax charges of as much as 70 per cent of the value of the benefit or payment received.
Holding commercial property in a Sipp has always been popular thanks to the many tax and other benefits it offers, particularly among owners of small businesses and professional practices, and investors with good knowledge of the sector. But it's an area that's ripe for transgressions. Often, clients who want to put property into their Sipp will "know what they are doing with regard to property but not with regard to pension rules,” says Martin Reynard, senior pensions manager at Blick Rothenberg.
The list of permitted commercial options is long and wide ranging, and stretches to care homes and even rivers with fishing rights. But residential property held in a Sipp will incur tax penalties, although there are exemptions for mixed-use premises such as a shop with a flat above or dwellings that are job related such as a caretaker’s flat. Because commercial property transactions tend to be complicated, "the Sipp provider will be all over it, with lots of scrutiny by a specialist property team, long due diligence questionnaires and checks on how the client is connected”, says Svenja Keller, head of wealth planning at Killik & Co.
The mistakes tend to be made months or years later by investors focused on a property's potential rather than pension law. For example, an investor surveying their property holdings might decide to convert an empty unit into a residential letting, forgetting that they would first need to sell the unit out of their Sipp. One individual in this situation collected rent for almost a decade before the error was discovered. It cost him “a horrendous amount of money”, says Mr Reynard.
Rules on connected parties are particularly easy to breach. If you own a property being sold to your Sipp, the transaction and all lease conditions must be on proper commercial terms and at arm’s length, using independent valuers and solicitors. There can be no discounted rental payment for you or a relative – it must be at the full market rate – and no skipping of payments. “You have to remember that it’s not your property and there can be no benefit to you as a tenant,” adds Mr Reynard.
In fact, if you fail to pay the rent the Sipp provider has a duty to take all necessary action against you including calling in the bailiffs.
Trading activities such as buying and selling of properties, or purchasing land for development, are also likely to attract penalties.
Investors have to be careful around pension contribution limits too. "Rules here can also catch people out," says Ms Keller. "Some people don't realise that their annual allowance is tapered and this is worked out on total taxable income – not just earnings."
In some cases, investors are unsure what their total income for the year is going to be, but make a contribution as they do not want to miss the contribution window.
Investors with Fixed Protection in place need to ensure that they are not auto-enrolled by an employer – something that is done every three years. “Even tiny contributions to a workplace pension can have huge consequences, leading to their protection being voided if the error is not noticed in time,” explains Ms Keller.
Situations that could trigger tax charges
Holding property that is deemed residential.
Converting an empty commercial unit into a residential one and receiving rent on this.
Getting rent paid to you as an individual instead of to your Sipp.
Under- or overcharging rent to yourself.
Making one or more mortgage payments yourself on a Sipp loan (Sipps are allowed to borrow up to 50 per cent of the value of assets held in them).
A Sipp borrowing more than 50 per cent of the net value of its funds.
Concessionary deals being done on rent or other terms.
Building up connected party rental arrears.