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:
What starts off as a promising attempt to apologize to the victims van Niekerk-Venter (right) scammed, unfortunately then turns into a “blame the haters” diatribe.