Pension tax simplification regime - Tenon summary

Following the Government of a number of changes to the pension tax simplification regime, which will come into effect on 6th April 2006 (A Day), Chris Ryan of local accountants and business advisers Tenon has issued a summary...

These changes will have a material effect on the impact of Pensions Simplification for many people. Whilst a number of points were amended the key issues relate to investment and tax free cash recycling.

Residential Property and Other Assets

From A Day, the Government will remove the tax advantages for investing in residential property and certain other assets such as fine wines, classic cars, art and antiques from registered pension schemes which are self directed. This includes all SSAS and SIPP arrangements. This is to prevent people benefiting from tax relief in relation to contributions made into self-directed pension schemes for the purpose of funding purchases of holiday or second homes and other prohibited assets for their or their family’s personal use.

To whom will the legislation apply?

The legislation will apply to all SSAS and SIPP arrangements. The legislation will apply to direct investment in residential property and in most forms of tangible moveable property (similar to what are currently called personal chattels in the regulations covering SSAS and SIPP investments at SI 1991/1614 and SI 2001/117 respectively) – these are
collectively referred to as “prohibited assets”. It will also apply to indirect investment in prohibited assets that are a close proxy for direct investment and to other forms of indirect investment that could be used to get around the new rules for prohibited assets. An example of this would be residential property owned by a company in which a SIPP held 100% of the shares. This is the structure that would have had to be in place for property purchase in Spain, for example, so that kills “the Spanish option”.

The legislation will define what is meant by “residential property” and how the rules will apply to property that is used for more than one purpose. This will ensure, for example, that if a pension scheme buys a commercially used property – such as a shop – this will not be classed as a residential property merely because there is an unconnected flat above the shop. However in line with the Government’s commitment to encourage investment in a diverse range of assets as part of pensions saving, certain products offering indirect investment in prohibited assets will not be subject to the new rules and will therefore continue to benefit from the tax advantages in the new pensions tax regime. To this end the Government is minded to allow SSAS and SIPPs to invest in genuinely diverse commercial vehicles that hold residential property or other prohibited assets. An example here would be the proposed Real Estate Investment Trust model on which the Government will be consulting shortly. These will not be available when A Day arrives.

This type of investment vehicle will allow genuine commercial investment by a SSAS or SIPP without the risk of abuse of the generous tax advantages of scheme members being able to enjoy personal or uncommercial use of the assets held in the investment vehicle. There will also be rules to prevent the use of such vehicles as a means to facilitate investment in prohibited assets with continued scope for personal use of those assets. The Government has made it clear that it will not hesitate to take action if it becomes clear that people are trying to use collective vehicles or other forms of pooled investment to get around the new rules on investment in prohibited assets.

How will the legislation work?

The legislation will be designed to remove all tax advantages from holding prohibited assets directly or indirectly in selfdirected pension schemes. If a SSAS or SIPP directly or indirectly purchases a prohibited asset the purchase will be subject to the unauthorised member payments charge in Section 208 FA 2004. This will recoup all tax relief given on the amounts used to purchase the asset.

This means that:

• The member will be subject to an income tax charge at 40% on the value of the prohibited asset
• The Scheme administrator will become liable to the scheme sanction charge in Section 239 FA 2004, which will usually be a net amount of 15% of the value of the prohibited asset
• If the set limits are exceeded the cost of the asset may also be subject to the unauthorised payments surcharge in Section 209 FA 2004, which is a further charge on the scheme member of 15% of the value of the asset
• If the value of the prohibited asset exceeds 25% of the value of the pension scheme’s assets, the scheme may be de-registered under Section 157 FA 2004, which would lead to a tax charge on the scheme administrator on the value of the scheme asset at the rate of 40% under Section 242 FA 2004.

So, if a pension scheme purchased a prohibited asset costing £100, there could be total tax charges of £70 on the scheme and its member, and the scheme could risk being deregistered. If the scheme were deregistered there would be a further 40% tax charge on the value of assets held in the scheme at the time of deregistration.

If the new rules dealing with investment in prohibited assets are applicable to a particular investment, the pension scheme will also be denied the benefit of tax exemptions on income and gains generated by the directly or indirectly held prohibited assets. Such income and gains will be subject to the scheme sanction charge in Section 237 FA 2004, which imposes tax at a rate of 40%. If the prohibited assets produce no, or low levels of, income, the above charge will apply to an amount of deemed income. This will ensure that pension schemes and their members cannot avoid the charges by investing in prohibited assets for personal use which do not generate any income.

Recycling of tax-free lump sum

The Government is also taking action to stop the potential abuse of the pension tax simplification rules by means of a device designed to boost the amount in a pension scheme through the artificial generation of tax reliefs. The device works by the scheme member withdrawing a tax free lump sum which is reinvested back into a registered pension scheme, automatically generating further tax relief on the amount reinvested. This in turn allows a further tax free lump sum to be paid out, so that the cycle can be repeated. This has become known as “recycling”. A number of clients have pointed out newspaper articles that have featured this. To prevent individuals from artificially boosting their pension funds by recycling tax free lump sums in this way an antiavoidance rule will be inserted into the new pension tax simplification legislation, to take effect from 6th April 2006 (A Day). The legislation will target cases where lump sums are taken with the sole or main purpose of reinvesting them in a pension scheme to create additional pensions saving through the additional tax relief granted.

For further information please contact: Chris Ryan Tel (01706) 355505 Email: chris.ryan@tenongroup.com