The new pensions regime introduced on 6 April 2006 (A-Day) was designed to simplify pensions. However, the rules for pension funds investing in unquoted shares remain complex.
Putting private company shares into a SIPP might sound like an attractive idea, but there are significant tax and other potential traps for the unwary.
Even if the traps can be avoided, trustees will need to ask themselves whether such shares are really a suitable investment for a pension scheme.
How the rules work
If a pension scheme holds shares in an unquoted company that buys residential property or moveable assets costing more than £6,000, the pension scheme may be deemed to have purchased those assets direct. In these circumstances a scheme member faces a tax charge of 40% or 55%. The pension scheme also faces a tax charge, typically of 15%, and a further charge of 40% will be levied on any income and/or gains subsequently arising on that asset. This means that if the company buys plant and machinery, for example a company car, costing more than £6,000, this could trigger substantial tax charges.
These rules will automatically apply unless the unquoted company is able to satisfy all of the following conditions.
- The company must be carrying on a trade, profession or vocation. Investment companies do not qualify for exemption.
- The company must not be controlled by the member, persons connected with the member and/or the SIPP either individually or together. This applies not only at the time of the initial investment, but has to be monitored on an ongoing basis.
- Neither the member nor a person connected with the member is a controlling director, otherwise the ownership threshold is reduced from 50% to 20%.
In addition to the threat of substantial tax liabilities arising from ordinary day-to-day transactions there are other practical considerations.
Valuations
Agreement of valuations with HMRC for tax purposes is notoriously difficult and can involve substantial professional fees. HMRC applies its own criteria, particularly where minority holdings are involved, which may mean they bear little resemblance to open market valuations.
Shareholder agreements
In many companies the shareholders are required to enter into an agreement which sets out the internal rules for governing the company and the arrangements for future share transactions. Pension trustees will need to understand the legal framework and take care to protect pension scheme members. If there is a shareholders’ agreement in place already the trustees will need to consider how onerous its obligations are and whether it provides sufficient protection for the SIPP. This again could lead to substantial professional fees.
Share transactions
Many companies now have schemes which involve staff being granted options to acquire shares. Share transactions involving a SIPP could provide a benchmark valuation for those employees exercising their options which affect their tax liabilities accordingly.
Company sales
Where a company is sold the purchaser will normally require indemnities and warranties from the vendors and that could create problems for the SIPP trustee.
Many SIPP providers have concluded that unquoted shares will not generally be an appropriate investment. This is in view of the compliance work involved in monitoring the ownership and management of those companies going forward, as well as the assets they hold.
Disclaimer: This document contains information from sources believed to be reliable but no guarantee, warranty or representation, express or implied, is given as to its accuracy or completeness. This is neither an offer nor a solicitation to buy or sell any investment referred to in this document. Articles in this publication may contain future statements which are based on our current opinions, expectations and projections. Smith & Williamson does not undertake any obligation to update or revise any future statements. Actual results could differ materially from those anticipated. Appropriate advice should be taken before entering into any transactions. Some of the investments mentioned in this publication are not suitable for all clients and they may contain a risk that some or all of your capital could be lost.
We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Limited 2006.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.