InvestmentsFeb 2 2015

Using property as a tax-planning tool

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The pension freedoms to be introduced in April in the UK appear to have been welcomed by all. More so now than before, the drawing of income can be fine-tuned using the new flexibilities.

Apart from simply providing a regular income, pensions can now be used as a tax-planning and, to some extent, an inheritance tax-planning tool. However, the flexibilities bring a few new challenges to overcome.

The rate at which income can be withdrawn is able to be increased significantly above the levels previously available through capped drawdown. These earlier levels were difficult to match with investment returns, meaning many pensions became sinking funds.

Employing an investment strategy in such cases is not easy and it becomes even more challenging when assets are illiquid. No more illiquid asset exists than directly held commercial property, so does this spell bad news for self-invested personal pensions (Sipps)?

The good news is that commercial property needs not be as illiquid as it is perceived. In fact, it is quite possible for property or land to be jointly owned with other parties, in variable proportions and paid out as a benefit in specie.

Thus tranches of the property can effectively be moved across a period of years from the pension arrangement to the client as flexible-access drawdown payments.

The following is an example of how this method can be employed:

A 70-year-old client’s Sipp holds assets totalling £600,000, of which £400,000 is farmed agricultural land and £200,000 is invested into liquid assets, such as equities and cash.

The client is in good health and has every expectation of living past age 75 and is looking to draw benefits from their scheme.

The investment market is depressed, so drawing their pension commencement lump sum (PCLS) from equity assets is unattractive. But the goal is to get the farmed agricultural land into their own name as soon as possible to take advantage of Agricultural Property Relief.

Rather than pay the client’s PCLS using the depressed illiquid assets, the Sipp operator creates a side trust into which the ownership of the commercial property is placed. The client is “paid” £150,000 of the agricultural land as an in specie lump sum, meaning the side trust initially holds the property for the benefit of the Sipp and client in the proportion 62.5/37.5 per cent.

The client does have other income varying around £20,000 per annum and elects to receive a flexible-access income payment of £80,000 immediately following the PCLS.

Again, the intention is not to use the liquid assets more than is necessary, so an in specie transfer of a tranche of property valued at £50,000 is made, representing the net pension payment, with some of the liquid cash being used to settle the income tax on this pension payment.

The side trust is varied to reflect the ownership of the land, which has moved to 50/50.

The client has the benefit of the beneficial ownership of part of the land and receives the proportion of the income relating to it. In subsequent years, further tranches of land can be paid across as additional flexible-access drawdown payments and varied to ensure the client never ventures into a higher tier of income tax.

The liquid assets of cash and equities can settle any income tax payments due. In a matter of a few years, the whole of the property will be the ownership of the client and the Sipp, while assets fully distributed will be wound up.

With transfers of beneficial ownership such as this, stamp duty land tax will apply and there are some administrative expenses in amending the side trust ownership.

In addition, where transfers occur between connected parties, an opinion of value is also required to ensure the transaction takes place at arm’s length terms.

The joint or phased ownership of commercial property can also be used when commercial property is acquired.

With the reduced annual contribution levels and borrowing capabilities now lower than previously available, it is increasingly difficult for a Sipp to purchase a property outright.

The phasing of a property purchase – particularly from the client themselves – over a number of years can be an attractive tax-planning tool where capital gains on the disposal by the client might be an issue.

Martin Tilley is director of technical services at Dentons Pension Management