Sarah Bradford explores the tax advantages of buying a commercial property through a self-invested personal pension plan or a small, self-administered scheme.
It can be highly tax-efficient to buy commercial property through a pension fund. This is a popular and financially effective option among small business owners who choose to purchase their business premises through their pension scheme to take advantage of the tax breaks on offer and to ensure that they, rather than a third-party landlord, benefit from the rent paid on the property.
Self-administered pension schemes
There are two types of self-administered schemes: self-invested personal pension plans (SIPPs) and small self-administered schemes (SSAS). These are known collectively as investment regulated pension schemes.
Both schemes allow you to buy property, and both are registered pension schemes, allowing them to access the tax breaks available to registered schemes.
SIPP
SIPPs are personal pension plans that allow the individual to choose where his or her pension savings are invested, rather than leaving that decision up to the pension fund manager. The range of investments that can be held in a SIPP is wider than those permitted in a personal pension scheme and, importantly, includes investment in commercial property, an option which is not available under a personal pension plan.
Contributions are paid into the plan, either by the individual or his or her employer. These attract tax relief. An individual can manage their SIPP themselves; or the SIPP provider or an investment manager can (as the trustee of the SIPP) manage the SIPP on behalf of the individual. Where property is purchased through the SIPP, it is the trustees that are the legal owner of the property.
It is not necessary for the SIPP to be able to buy the property outright, as it is permissible to borrow up to 50% of the value of the property. This is particularly useful if the pension fund is not large enough to meet the full cost of the property.
If you already own a commercial property, you can transfer it into the SIPP.
It should be noted, however, that it is not possible to draw on a SIPP before age 55.
SSAS
Generally, a SSAS is used as a workplace or occupational pension scheme. It is usually set up by the company director or directors, but can be open to other employees.
As with a SIPP, the SSAS does not need to buy the property outright; as for a SIPP, borrowing is restricted to a maximum of 50% of the fund.
What type of property?
A SIPP or SSAS is permitted to own a commercial property outright, but not a residential property. Whilst it is possible for a SIPP to invest in a residential property, this can only be done as a small part-owner where the property is not for personal use and is via a genuinely diverse commercial vehicle, such as a real estate investment trust (REIT). The restrictions on residential property mean that in most cases SIPP/SSAS property investment is restricted to commercial property.
Permitted investments include business premises, factories, offices, shops etc., as well as hotels, care homes and prisons. Investment in student halls of residence is also permitted, but not flats or houses let to students.
Where a commercial property also has a residential element (e.g., a shop with a flat above), the residential element can be held by the pension fund as long as it is not occupied by a member of the scheme. Thus, it is not possible for the shopkeeper to buy the flat and the shop through his SIPP and live in the flat, although the SIPP can buy the shop and the flat and let them to an unconnected shopkeeper.
The property can be refurbished or developed as long as it continues to fall within the list of permitted properties.
The business is a tenant of the SSIP/SSAS and must pay rent at a commercial rate.
Tax benefits
Tax relief is available for contributions to registered pension schemes, so contributions to SIPPs and SSASs benefit from relief.
Tax relieved contributions can be made to the higher of 100% of earnings and £3,600, subject to the availability of the annual allowance. The annual allowance for 2021/22 is set at £40,000. However, this is restricted for high earners. The restriction bites where a person has both adjusted net income of more than £240,000 and threshold income of more than £200,000. Broadly, adjusted net income is income including pension contributions, and threshold income is income excluding pension contributions. Where both tests are met, the annual allowance is reduced by £1 for every £2 by which adjusted net income exceeds £240,000 until the minimum amount of the annual allowance is reached. For 2021/22, this is set at £4,000.
Unused allowances can be carried forward for up to three years, providing an effective limit on contributions of up to £200,000 over a four-year period where earnings permit.
The ability to make contributions in respect of non-earners up to £3,600 gross (£2,880 net) a year means that contributions can be made in respect of children and non-working spouses to further build up the fund. Tax relief is given at source on the contributions, even if the contribution is made in respect of a non-taxpayer, providing an additional benefit as the fund has the benefit of contributions of £3,600 for a cost of only £2,880.
Contributions made by individuals attract tax relief at the individual’s marginal rate.
Where contributions are made by the company, these are deductible for corporation tax purposes.
Any rental income received by the pension fund in respect of the property is tax-free. A valuable benefit is that because the rent is paid to the pension fund, the members ultimately benefit from it. The rent is not lost to a third-party landlord.
A further benefit is that any capital appreciation of the property whilst in the pension fund is free of capital gains tax (CGT). On retirement (at age 55 or above), 25% of the value of the fund can be paid as a lump sum. Should the member be unfortunate enough to die before retirement, the whole fund may be paid as a lump sum, free of inheritance tax.
Example: Purchase of business premises by a SSAS
A Ltd is a family company. The business was initially run from the family home. However, due to expansion, the family decides to move the business to dedicated business premises.
The company has set up a SSAS, and regular contributions are made into the scheme by the members and the company.
The contributions attract tax relief and, as such represent a tax-efficient investment.
The family finds suitable business premises and decides to purchase the premises through the SSAS.
The fund is not sufficient to purchase the property outright, so it borrows 30% of the purchase price.
The property, which is owned by the SSAS, is let to the company for a rent of £3,000 a quarter. The rent is tax deductible in computing the profits of the company, but rather than going to a third party, it is paid in the SSAS (which will benefit the family members). The rent is tax-free in the hands of the SIPP.
The rent paid into the SSAS helps to build up the value of the SSAS. This may provide the opportunity for the SIPP to lend money to the company, if needed in the future. If this route is taken, the interest paid on the loan is paid into the SSAS rather than being lost to a third party.
If the SSAS decides to sell the property, the fund benefits fully from any appreciation in value as there is no CGT to pay on disposal of the property.
‘Win-win’ situation
As demonstrated by the above example, buying commercial premises through a SSAS or a SSIP can be a ‘win-win’ situation, partly as a result of the tax benefits available and partly because any rent paid for the commercial property is not lost to a third party.
Practical tip
Consider buying or transferring your business premises through a SSAS or a SIPP to take advantage of the associated benefits. Professional advice should be sought if contemplating an investment of this nature.
