Pension Scheme Conversion of Commercial Property to Residential...

Pension Scheme Conversion of Commercial Property to Residential

We are regularly asked whether it is possible for a SSAS to acquire a commercial property (or land)

and convert it into residential property, thereby benefitting from a substantial tax free gain on the

sale of the property. With the high current demand for residential property, high supply of low cost

unused commercial property and easier planning rules, this would be a popular strategy for pension

scheme investment. The answer is “maybe” and this mailing aims to explain the issues, complexity

and possibilities available.


The Rules

The basic rule is that a UK pension scheme can purchase commercial property or land and can obtain

planning permission to convert or develop that property to lease or sell. There is a proviso that if the

pension scheme is deemed as “trading” then the profits will be taxed as a trading receipt (i.e.

corporation tax is payable). This is established by applying the HM Revenue & Customs Badges of

Trade to the activity: http://www.hmrc.gov.uk/manuals/bimmanual/BIM20205.htm. We feel that by

only carrying-out a development once or infrequently, any challenge of trading can be avoided.

The other essential rule is that the pension scheme must not at any time hold residential property or

it will be subject to extremely penal tax charges. The HM Revenue & Customs definition of the point

at which a property conversion becomes residential is contained in the following link:

http://www.hmrc.gov.uk/MANUALS/RPSMMANUAL/rpsm07109090.htm.


On speaking to architects, we understand that in the case of property conversion, the certificate of

habitation referred to by HM Revenue & Customs is actually a Completion Certificate that the

architect will issue.


It is therefore essential that with a commercial to residential conversion, the property is removed

from the pension scheme BEFORE the architect’s Completion Certificate is issued.


The Problem

This rule causes a problem for the pension scheme because it is very difficult to sell an uncompleted

property. In most cases the purchaser’s solicitor will request a copy of the Completion Certificate

and will advise their client not to proceed if this is not forthcoming. In addition, it is practically

impossible for a purchaser to obtain a mortgage without a Completion Certificate.


The Solution

We know of three methods that can be used to remove the uncompleted property from the pension

scheme although none are ideal and have their complications.


1. Find a Cash Buyer

The purchaser can be a connected or unconnected party. If connected, an open market valuation is

necessary. Provided the purchaser is aware that the conversion is not complete and there is some

further work to carry out to obtain the architect’s certificate, there is no reason for the sale not to

proceed. The purchaser can then sell-on the property and potentially make a small gain for the

completion work they carried out. Alternatively they can occupy or lease the property.


2. In-specie Loan to Unconnected Borrower

The SSAS is permitted to make loans to genuinely unconnected parties of up to 100% of its value and

can negotiate the terms with the borrower provided they are deemed to be prudent, secure and

commercial. A part-completed property could therefore be lent in-specie (i.e. the property

ownership is transferred to the borrower by way of a loan) to an unconnected party.


Example:

Jeanette has used her SSAS to part complete a conversion of a shop with offices above into a house.

She bought the shop for £75,000 and spent £50,000 on the conversion. The property is now valued

at £175,000.

She agrees with a local property developer to lend the property to them for £175,000 at 10% p.a. by

transferring the ownership of the property to the developer and taking a legal charge over the

property as security (there are some specific requirements to meet where residential property is

used as security for a loan from a SSAS). The developer completes the conversion over a three

month period and sells the house six months later for £220,000.

From their sale proceeds they repay Jeanette’s SSAS £188,125 (£175,000 capital and £13,125 loan

interest for nine months).

The gain by Jeanette’s SSAS and tax saved is:

Growth in property value during conversion £50,000

Loan interest received £13,125

Tax saved (£14,000 CGT assuming higher rate / £2,625 income tax assuming 20%) £16,625


3. In-specie Loan to Sponsoring Company

This is more complex and requires larger funds but is based on the underlying principle that a SSAS

can lend up to 50% of its net value to a sponsoring company. The conditions are:

The loan must be secured by a first legal charge on an asset with a value that at least covers

the loan capital and interest payments over its term

The maximum term is five years

Standard HMRC interest rate is 1% over bank base (currently 0.5%)

Loan capital and interest must be repaid at least annually in equal instalments over the term

of the loan.


This method can be explained by using an example:

Steve and Dave run a minicab and chauffeur business. They have combined personal pensions worth

£250,000. They establish a SSAS and transfer-in the personal pensions. They then buy a disused pub

in Bolton for £50,000 and decide to convert it into two residential flats which they believe will fetch

£140,000 each. The cost of the redevelopment is £60,000.

The SSAS commences the conversion and spends £50,000 to take the project near to its completion.

At this point the property is valued on the open market by a qualified valuer at £150,000 which is

50% of the total SSAS value which at that point is £300,000.

Steve and Dave establish a separate property development company that is funded by some cash

(assumed at £15,525 - see below) and which joins the SSAS as a participating company and pays a

small pension contribution to formalise its participation.

The SSAS then makes a one year in-specie loan of £146,675 to the new company by transferring the

property to the company for the value given in the valuation and the company pays £3,325 to the

pension scheme as a part purchase of the property (this is to ensure the value of the security of

£150,000 covers the loan capital and interest payments over its term). The SSAS takes a first legal

charge over the property as security for its loan.

Steve and Dave’s property company complete the conversion which costs another £10,000 and

obtain the completion certificate from the architect. They then sell the flats for £280,000 within one

year of the pension scheme loan being made.


The SSAS loan and interest accrued for one year are then repaid to the SSAS from the sale proceeds.

By making some assumptions of the costs, the estimated return and tax payable/saved is as follows:

Gain by the SSAS

Growth in property value during conversion £50,000

Loan interest payable by property company (assume repaid after one year) £2,200

Tax saved (£14,000 CGT assuming higher rate / £440 income tax assuming 20%) £14,440

Gain by the Company

Property sale proceeds (after costs assumed at £5,000) £275,000

Less costs of development/loan

Pension contribution £200

Part purchase of property from SSAS £3,325

Stamp Duty Nil

Solicitor’s fees for conveyancing and legal charge £1,500

Valuer’s fee £500

Completion of residential conversion £10,000

SSAS loan capital repayment £147,675

SSAS loan interest repayment £2,200

Total £165,400

Net proceeds £109,600

Tax payable (assume initial funding of £15,525 was a director’s loan and a


Corporation Tax rate of 20%) £18,815

Total gain (£14,440 tax saved by the SSAS and £90,785 net gain to the company) £105,225

Incidentally, the property company could pay an £80,000 pension contribution to the SSAS (£40,000

each) from the proceeds which would save a further £16,000 Corporation Tax.

Naturally, where a SSAS is carrying out a commercial to residential conversion we have to monitor

the development to ensure it is not completed within the pension fund. We therefore ask for dated

photographic evidence on a monthly basis during the process and a copy of the completion

certificate.


A major complicating factor is VAT which is often payable on the purchase of a commercial property

and on the costs of conversion. This would add an additional 20% to the costs which could make the

project unviable. We are not VAT experts but our understanding of the VAT position is as follows:

Firstly, at the point of purchasing the commercial property, if this is already subject to VAT, it is

possible to submit a form 1614D to the VAT office to avoid paying VAT on the purchase price

(because it is being purchased with the intention of a conversion to residential).

Secondly, as long as the pension scheme intends to make a zero rated taxable supply (by selling the

converted property either as a freehold interest or a lease over 21 years) of the partly completed

residential conversion it will be able to register for VAT and recover VAT incurred on the conversion

costs. It should be added that some conversion costs are blocked from VAT recovery (anything that

is not building materials such as carpets, curtains, fitted wardrobes and white goods). A pension

scheme is not permitted to purchase these anyway without incurring heavy tax penalties.

Thirdly, provided the sale of the partly converted property meets the following conditions, there is

no VAT on the sale price as this is zero rated:

 A real and meaningful start to the conversion has been made

 there must be a sale of the property or grant of a long lease

 it must be a conversion of a non-residential property

 it must not be converted into a holiday home

 it must be the first grant of a major interest

 it may be necessary to obtain a certificate (relevant residential/charitable use).


The final stage is that whoever buys the part completed property also needs to carry out some

meaningful work to the property if they want to sell it on with no VAT.

Unfortunately, the in-specie loan scenarios given above do not achieve the condition of a sale or

grant of a long lease. This means the SSAS would not be allowed to recover VAT on the conversion

costs although provided the borrower carried out some meaningful work to the property they could

sell it with no VAT.


Please note that we are not VAT experts so please do not consider this article to be VAT advice.

We hope this is of interest and explains the issues involved with this commonly asked question. For

more information or if you would like to discuss this further please contact us: