PensionsAug 19 2016

Opening doors for small companies

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Opening doors for small companies

The Brexit vote has made some investors nervous to invest and potentially more difficult for those investors who still want to. The cut in interest rates to historic lows may make borrowing more appealing, but you still have to jump through a lot of hoops to get approval from the bank in the first place, and for many businesses this can be an additional hassle that they do not want.

There are, however, other options for business owners that have accumulated a pension fund. Making the pension fund work for the company, rather than just drawing money out in the way of pension contributions, benefits the company and the pension in a double whammy.

Commercial property

The first investment option is something that many businesses already use – commercial property. It should also be remembered that even if a firm is not office-based, there is much more to commercial property than just warehouses and offices.

A self-invested personal pension (Sipp) and small self administered scheme (Ssas) allow commercial property investment, so this will be available to anyone with enough money in these pension funds.

There is added flexibility for the pension to borrow to help with the funding of the property. Buying a commercial property for the company to use is something that can be of a real benefit especially in light of the restrictions on contributions that high earners are currently suffering.

Rental income from the property will build the fund without impacting on the amount left for personal or employer contributions. Commercial property comes in many forms, and different types can suit different businesses.

There is still a significant amount of bare land available for purchase and this can be bought within a scheme – even initially without a purpose. The asset can be held in anticipation that it will go up in value or be used for development.

Buying a piece of land to develop into something to benefit the company is a great way to add value, as the pension can also pay for the development, or it can just be left for parking or storage – if that is required.

Finding the right piece of land or commercial property to benefit the company is key as the company will need to pay market rent for the use of it.

However, should the company be sold – such as at retirement – the pension can still benefit from the rental received by the new tenants. This means it can continue to provide an income for many years and even to their beneficiaries on death.

The changes made in the 2016 Budget statement regarding stamp duty land tax (SDLT) also adds to the appeal of buying commercial property with a pension fund because unless the property is very expensive it will now attract significantly less tax on purchase than before, reducing the upfront costs. It will also be free from capital gains tax if and when it is eventually sold.

Loanbacks to the company

Making a loan from a pension scheme to the company is another way to support the company with pension money.

But the first thing that should be made clear to anyone considering a loanback from their pension is that it should never be used to prop up a failing company. This is for two reasons. The first is that if you lend to the company and it still fails you will have lost this money from your pension scheme.

Given the levels of annual allowance available these days, and the fact that if the company has failed, then it would not be around to pay wages or pension contributions so building the fund up again will be difficult.

In addition, the scheme is likely to lose more than just the loan – there will be unauthorised payment charges and even the possibility that the scheme is deregistered.

If the loanback is to continue to build a successful company then it can be a really good option. Not only does it remove the need to use a bank, especially as they are still reluctant to lend to small businesses, it will put the money locked away in the pension to good use.

Loanbacks are only available from a Ssas, not from Sipps because they can only lend to unconnected third parties. There are five areas that need to be considered when making a loanback. Security is usually the biggest issue. The loan must be secured throughout its term by a first charge over an asset with a value at least equal to the value of the loan plus interest.

The interesting thing about the asset is that it does not actually have to be owned by the company, but it cannot have a charge, even a floating charge over it at any point during the loan.

It is possible to change the security during the period of the loan, should the asset need to be sold, but the replacement security must be at least equal to the market value of the original asset or, if lower, the value of the outstanding loan plus interest.

What the actual security can be will depend on the Ssas scheme administrator. Some will allow a charge over taxable property – even residential property in some cases – but it is likely to be structured so the charge is over the proceeds of sale rather than the asset itself.

This is a grey area, and to be certain no unauthorised payment is deemed to have been made, it is prudent to be confident the scheme is not acquiring an interest in taxable property. In most cases security is over a commercial property or other asset easily valued.

The minimum interest rate that can be applied to a loanback is determined by HM Revenue & Customs (HMRC), and must be no less than 1 per cent above the average clearing bank base rate for six nominated high street banks rounded up to the nearest 0.25 per cent.

Thankfully this is published on the HMRC website and it should be noted that it is the minimum rate – although it is unlikely that a company is going to want to pay anything higher. Some have been caught out by setting a higher rate and then struggled to pay.

The term of a loanback must be set at outset and it cannot be more than five years. It is, though, possible to pay it back early if the company wants to.

As with scheme borrowing, the loan cannot be more that 50 per cent of the value of the scheme. This is calculated immediately before the loan is made and not re-tested unless there are additional loans made.

It means that should a member be taking an income, or there is a drop in the value of the assets, then the loan will not suddenly become excessive and cause any unauthorised charges.

The loanback must be repaid in equal instalments of capital and interest for each complete year of the loan. If loan repayments are missed or are not sufficient to meet the repayment requirements each year, then an unauthorised payment is deemed to have been made, which will cause tax charges – it should be avoided at all costs.

Small businesses

Small businesses are in a really good position for their senior executives to pool their pensions and put them to work, provided it is thought through and done for the right reasons.

If you take the volatility in the stock market, then there may not be a better time to invest in something closer to home such as the sponsoring employer, or something more tangible that can continue to provide an income well into retirement.

Claire Trott is director and head of pensions technical at Talbot and Muir