Adviser > Technical Central > Information & guidance > Investment > Investment rules
Investment rules
Since A-Day there has been only one set of investment standards for all registered pension schemes. This means that small self-administered schemes (SSASs) and self-invested personal pensions (SIPPs) are covered by the same set of HM Revenue and Customs investment rules as every other type of pension scheme.
Investments are now far more straightforward and flexible, but there are a limited number of restrictions on specific investments and not everything is better than it was before A-Day.
Any investment held before A-Day is still subject to the rules in force when it was entered into and is not affected by the new rules unless there's a change to the original terms.
TRUSTEE’S BORROWINGS
Trustees of pension schemes can borrow money, provided it is used to benefit the pension scheme.
What can this money be used for?
This money can be used by the Scheme Trustees for any benefit but it is usually used to enable the Trustees to:
- buy commercial property
- make a loanback to the principal employer (occupational pension schemes only)
- buy shares.
Who can the money be borrowed from?
This money can be borrowed from any of the following:
- individual
- company
- financial institution.
If the money is borrowed from a connected party (see later), the loan has to be made on commercial terms.
How much can the Trustees borrow if there are no outstanding borrowings?
The maximum amount that the Trustees can borrow is 50% of the current value of the scheme. 100% of scheme assets plus any scheme borrowings can be used to buy an asset. This means that the scheme could buy an asset worth 150% of the current value of the scheme.
The 50% limit is the total amount that a scheme can borrow. There is no separate limit for any associated costs involved in the purchase of the asset e.g. VAT.
How much can the Trustees borrow if there is already an outstanding loan?
The maximum amount that the Trustees can borrow is 50% of the current value of the scheme less any outstanding loans. The current value of the scheme can't include the current value of any existing borrowings.
Example
The current value of the registered pension scheme is £300,000
Outstanding borrowings of £50,000
The maximum amount of additional borrowings can't be more than £75,000. Calculations are below:
(Current value - existing loan) x 50% - existing loan = Allowed borrowing
(£300,000 - £50,000) = £250,000 x 50% = £125,000 - £50,000 = £75,000.
How is the current value of the scheme calculated?
This is the market value of any uncrystallised and crystallised assets under the scheme. This can include the value of any dependants’ scheme pension under unsecured and alternatively secured pension funds, but it can't include any annuities in payment.
What happens to Trustees borrowings made before 6 April 2006?
Any borrowings that took place before A-Day are unaffected by the new limits; however they have to be taken into account if the Scheme Trustees decided to borrow more money. HMRC have confirmed that if the new borrowing is to repay an existing loan, this won't trigger a 50% test so long as the total amount borrowed doesn't increase. Extending the term or changing the interest rate won't trigger a test either. A test will be needed however if interest due on the previous loan hasn't been paid and is added to the new loan.
LAND AND PROPERTY
There are many advantages in a pension scheme owning property or land, including:
- no Capital Gains Tax liability when the property is sold
- normally there will be no Inheritance Tax liability as the property is an asset of the scheme
- the rent paid by the tenant is tax deductible as a business expense, and
- the rent received by the pension scheme helps to increase the retirement benefits.
It is worth remembering that property is an illiquid asset and is likely to restrict the diversification of the fund and will need ongoing maintenance plus regular tenants to generate good returns.
What type of property and land can a pension scheme purchase?
- Commercial property, including:
- hotels
- student accommodation
- care homes
- prisons
- shop
- offices
- overseas commercial property
- development land.
What type of property can a pension scheme not invest in?
A pension scheme can't invest in residential property. This includes:
- a building or structure that is used or suitable for use as a dwelling
- any related land that is wholly or partly the garden for the building or structure
- any related land that is wholly or partly grounds for the residential property and which is used or intended for use for a purpose connected with the enjoyment of the building
- any building or structure on any such related land
- a beach hut
- a property that also has a residential element (see some exemptions to this below). For example a building where some of it is used for commercial purposes, such as a shop, with an inter-connected residential area, such as a flat. The whole property will be treated as residential as it is suitable for use as a dwelling. Different parts of a building are inter-connected if they share a common entrance and where you can move from one part to another without moving through common areas.
What types of residential property can be bought by a pension scheme?
A pension scheme can't normally invest in residential property, but there are some exceptions. Examples of some of these exceptions are:
- a piece of land that is having a house built on it as long as the land and house is disposed of before it becomes habitable
- a commercial property that is being converted to a residential property provided that the property is disposed of before it becomes habitable
- a property that is occupied by an employee who is neither a member of the pension scheme or connected to a member of the pension scheme and is required as a condition of employment to occupy the property e.g. a caretaker's flat
- a property that is occupied by a person who is neither a member of the pension scheme or connected with a member of the pension scheme and the residential element of the property is used in connection with the commercial element as an investment of the pension scheme e.g. a flat above a shop that is leased from the scheme with the shop, where the flat is occupied by the shop keeper.
LOANS
Loans to the employer is one way in which the pension scheme can be used to raise finance, whilst at the same time providing an investment return to the fund for the benefit of the pension scheme. No loans can be paid to the scheme member or anybody connected to the scheme member.
Who can the money be lent to?
If the pension scheme is an occupational pension scheme the money can be lent to the sponsoring employer or a third party. The third party can't be anybody connected to the member or the sponsoring employer. If the pension scheme isn't an occupational pension scheme the money can only be lent to a third party. A scheme that isn't an occupational pension scheme can't lend any money to an employer that's connected to the scheme member.
How much can the scheme lend?
Up to 50% of the market value of the scheme can be used. The loan shouldn't be granted for more than 5 years, but under certain circumstances the loan can be extended by up to 5 years.
When can a loan be for more than 5 years?
If a loan is made to a sponsoring employer and that sponsoring employer gets into financial difficulty during the initial 5 year period, the loan may be rolled over for up to a further 5 years. This can only be done once.
What would happen if the money was lent to a member or somebody connected to the member?
If a loan is paid to a:
- scheme member
- person/company connected with the member
- person/company connected to the sponsoring employer
then this will result in an unauthorised payment equal to the amount of the loan and an unauthorised payment charge of 40% of the amount of the unauthorised payment. In addition to this if the amount of the unauthorised payment exceeds 25% of the fund value there will also be a scheme payments surcharge of 15% bringing the total tax charge to 55%. A scheme sanction charge of 40% of the chargeable amount will also be levied on the scheme administrator.
What security must there be for the loan?
The amount of the loan has to be secured throughout the term as a first charge on any asset owned by the person borrowing the money. This asset must be worth at least the same as the amount being lent plus the value of all the interest due over the term of the policy. If the asset that is being used as security is replaced by a new asset, the value of the new asset has to be at least equal to the value of the outstanding loan, including interest. In practice the security is likely to be a property.
What interest must be charged?
The minimum interest rate a scheme can charge is calculated using the average of the base lending rates of the following 6 banks plus 1%, rounded up to the nearest multiple of ¼%:
- The Bank of Scotland
- Barclays Bank plc
- HSBC plc
- Lloyds TSB plc
- National Westminster plc and
- The Royal Bank of Scotland plc.
All loans have to be repaid in equal instalments of capital and interest for each complete year of the loan.
What happens to loans made before 6 April 2006?
If a loan was granted before A-Day and the terms are changed after A-Day, the whole loan will be subject to the new rules if there is additional borrowing. Otherwise the loan can continue until the end of its term.
If a pre A-Day loan is rolled over after A-Day this is not treated as a change in repayment terms if:
- there is an amount outstanding on the date by which the amount should have been paid
- the rollover doesn't exceed a period of more than 5 years
- there has been no previous rollover on or after 6 April 2006
- there are no other changes to the repayment terms of the original loan.
STOCKS AND SHARES
A pension scheme can purchase shares in any company, regardless of whether or not they are listed on a recognised stock exchange. An occupational pension scheme is however restricted in the amount of shares that it can purchase in the sponsoring employer or employers.
What is the limit on the shares in the sponsoring employer (occupational pension scheme)?
Up to 5% of the fund value can be held in shares of the employer or an associated company. The Trustees can buy shares in more than one sponsoring employer of the scheme providing that at the time the shares are bought the market value of the shares is less than 20% of total value of the scheme. There is no restriction on the maximum percentage of shares that can be held in one company. For example a scheme could potentially own 100% of the shares of a company providing that the amount being invested is less than 5% of the fund value mentioned above.
What happens if the scheme held shares in respect of the sponsoring employer(s) before 5 April 2006?
If an occupational pension scheme held shares in a sponsoring employer before 6 April 2006 the shares can continue to be held. If however, the scheme buyes shares in a sponsoring employer after 6 April 2006 the 5% limit will apply and the total value of shares including the value of the shares held prior to 6 April 2006 will have to be taken into account.
What is the limit on the shares in the sponsoring employer (personal pension scheme)?
A personal pension scheme doesn't have a sponsoring employer, therefore the 5% limit that there is for occupational pension schemes doesn't apply. However a pension scheme can't invest in taxable property. This means that a personal pension scheme can't invest in an unquoted company as the assets of the unquoted company will be regarded as taxable property.
CONNECTED PARTIES
Where a transaction takes place between a scheme and a connected party in either of the 3 categories below the transaction has to be done at arm’s length or it may create an unauthorised payment.
Category A Transactions
A transaction between the scheme and the member or sponsoring employer.
Category B Transactions
A transaction between the scheme and people connected with members and/or connected employers. Connected for this purpose means anyone who falls within the definition below:
People connected to the member:
- the individual's spouse or civil partner
- a relative of the individual
- the spouse or civil partner of a relative of the individual
- a relative of the individual's spouse or civil partner
- the spouse or civil partner of a relative of the individual's spouse or civil partner. The HMRC has produced a useful flowchart which illustrates this - http://www.hmrc.gov.uk/manuals/CG1manual/cg14583.htm
Category C Transactions
A transaction between the scheme and a third party, which is directly or indirectly for the benefit of a member or sponsoring employer.
What is a connected company
A company is connected with a person if that person has control of it, or if that person and the persons connected with him together have control of it.
Who is the sponsoring employer?
In relation to an occupational pension scheme this means the employer, whose employees benefit from the scheme.
What is an arms length transaction?
This is a normal commercial transaction between two or more parties.
What happens if this is not done at arms length?
Any transaction between anyone within categories A, B or C has to be made at an arms length. If it's not done at arms length and as a result of this the member financially benefits the difference between the actual value and the arms length value will be taxed as an unauthorised payment. Scheme trustees should ensure that when a connected party transaction happens that they obtain an independent valuation and ensure that the market value is paid.
PERSONAL 'CHATTELS'
The following assets, which are classed as personal 'chattels', are not allowed:
| Antiques | Films | Fine wines | Gem stones |
| Kruggerands | Jewellery | Oriental rugs | Rare books |
| Stamps | Vintage cars | Works of art | Yachts |
OTHER CONSIDERATIONS
Value stripping investments
The rules discourage schemes from investing in assets that are designed to remove value from tax-privileged funds. These rules:
- provide that all investments must be acquired, disposed of or leased on commercial terms
- prevent the use of investments and changes to investments that allow for value to be taken out of scheme assets
- prevent the use of annuities which provide that certain payments can be made directly or indirectly on the death of members (e.g. payments made by an item sold as a package with the annuity which allow for the balance funds to be repaid on death), and
- provide that all loans to third parties have to be on normal commercial terms.
Where value is passed from the scheme to either a member or a sponsoring employer, the amount of the value shifted out of the scheme is treated as an unauthorised payment if the amount passed is other than what can be expected on arms length terms. A scheme sanction charge will also be made on the scheme.
Personal use of assets
HM Revenue and Customs has stated that any non-commercial use of an asset by a member or an associate of a member will create an unauthorised payment charge on the member.
Unauthorised payment
Where an unauthorised payment is made to a member or an employer the tax charge will be 40% of the amount of the unauthorised payment.
Scheme sanction charge
The scheme administrator will be liable to a scheme sanction charge on all charges except benefit in kind charges on non wasting assets. The amount of the scheme sanction charge is 40% of the scheme chargeable payment. However where the member or sponsoring employer has been subject to an unauthorised payments charge and has paid the tax due, a deduction will be made to the amount of the scheme sanction charge.
The amount of the deduction is the lesser of
- 25% of the amount of the scheme chargeable payment, and
- the actual amount of tax paid by the member or employer on an unauthorised payment.
This information is based on our current understanding of the relevant Finance Acts and other relevant legislation.
Published 17 May 2006
Updated 12 October 2010
For professional advisers only
