Taxman eases up on commercial property

Investors who bought commercial property through their pension before 2006 are set to save tens of thousands of pounds on tax charges if they renegotiate their mortgage.

Clarification of the rules from HM Revenue and Customs (HMRC) could see thousands of investors able to get a loan at a better rate of interest . Previously, property owners who wanted to renegotiate their loans were reluctant to act in case they were hit by an unauthorised tax charge, as HMRC had not made clear whether this would apply.

This charge could run into tens of thousands of pounds on just one property, according to John Moret at pensions provider Suffolk Life.

“People haven’t been able to renegotiate the loans as the potential tax charge would have dissuaded them but we expect a significant number will now look to renegotiate,” says Moret.

“In principle, this makes a great deal of sense. It will affect a healthy proportion of clients,” agrees Billy Mackay at AJ Bell, the pension provider.

The rare piece of good news came after the Association of Member Directed Pension Schemes, the pensions body, lobbied HMRC to explain how the rules would be applied.

Before April 6 2006, known as “A-day” when pensions in the UK were simplified, people who bought commercial property through a self-invested personal pension (Sipp) could borrow up to 75 per cent of the value of the property to do so.

After A-day, the rules were tightened so that people could only borrow 50 per cent of the value of their Sipp fund. With plummeting pension values making this 50 per cent an ever smaller amount, this meant many investors were locked into loans paying high rates of interest on their properties.

Moret estimates that if all those who have a commercial property in a Sipp were to renegotiate their loan, the tax saving – or cost to the Revenue – could be hundreds of millions of pounds.

While loans are harder to come by in the present climate, for those who are able to get a deal, it is likely to be at far lower levels of interest than a few years ago.

“Some of these loans would have gone back several years where interest rates might have been into double figures,” points out Moret.

HMRC is also allowing leases on commercial properties in a pension to be renegotiated, for example by lowering the rent.

Around half of Suffolk Life’s clients who have commercial property in their Sipps have loans above 50 per cent of the value of their pension, so could be set to benefit from the new rules.

Most people who buy a commercial property through a Sipp use the property in their business.

The tax-efficient route is popular among professionals such as barristers and accountants. Such people tend to buy their own office, perhaps in partnership with others.

Buying a commercial property through a Sipp means that rental income is paid into the pension free of tax, and then grows tax free in the pension. The risk of tenant default or damage is reduced, as the Sipp investor’s business is the tenant.

The tax considerations are by far the main reason that people purchase commercial property through a Sipp, says Moret.

“It would normally be a tax-driven decision in many cases. Clearly, there are people who just invest in property as it’s a good asset over the long term but for many it’s as much driven by their own business requirements.”

However, amateur investors are usually cautioned against buying commercial property in their Sipp.

“In most cases, we think it’s a bad idea to buy commercial property in a Sipp when you don’t have a connection with the business,” says Danny Cox, head of advice at Hargreaves Lansdown. “The transaction costs are high and there is a danger of amateur commercial property ‘buy-to-let’.”

Difficulties can also arise when an investor is retired and is taking rental income from the commercial property in their Sipp. If the property is revalued, this could trigger a dramatic drop in income.

Also, if an investor wants to buy an annuity with their pension, the commercial property would have to be sold – as all pension assets are encashed when an annuity is bought and the money is transferred to the life insurance company.

If the commercial property forms part of the family business, this could be an issue.

“Careful preplanning is needed, particularly if the business is to pass on to children,” says Cox. This could include arrangements for the children in a business to buy the property from the parent’s Sipp, for example.

Residential property, whether as a buy-to-let investment or for personal use, cannot be purchased through a pension scheme.

The government had planned to allow people to invest in residential property but withdrew this in the pre-Budget report of 2005, saying it could be exploited by wealthy people looking to get tax relief on the purchase of a second home.

There has been speculation that the government could again look at allowing residential property investment through a Sipp – effectively a U-turn on its U-turn – as a way of boosting the stagnant housing market but most pension experts think this unlikely.

Some Sipp providers may struggle to survive

Some providers of self-invested personal pensions (Sipps) may struggle to survive the recession, advisers have warned.

These pension companies Many Sipp providers’ business models typically take a cut of the rate paid on clients’ bank deposits, so have been hit by the sharp dropfall in interest rates.

Some have previously taken up to 2 per cent. But with interest rates now at 0.5 per cent, Sipp providers are severely limited in how much they can take in fees.

“Any Sipp provider who relies on interest rate fees will have holes in their business model,” warned Martin Tilley at Dentons Pensions Management.

Hornbuckle & Mitchell recently raised its annual fee and said that a number of smaller Sipp providers were planning to increase their fees as well.

Standard Life also recently repriced its Sipp, which advisers said made it more expensive for holders of smaller pensions.

Advisers have also warned that providers may struggle with service as they seek to cut costs.

But larger providers insisted that it would not be in their interests either to raise charges or to skimp on service.

“Price is becoming an increasing factor in people’s decision making process, particularly in current market conditions,” said Billy Mackay at AJ Bell, the Sipp provider. “If you’re in the top five players I think it will be difficult to increase charges because competitors will pick up on that quickly.”

However, he believed there could be some consolidation among smaller Sipp providers. The top five Sipp providers control over two-thirds of the market, according to a recent report from the Financial Services Authority.

AJ Bell, Suffolk Life and Dentons, all higher end Sipp providers, said they had no plans to increase charges.

The FSA is currently reviewing the way that Sipps charge customers, with many accusing providers of levying fees that are too

Be in it for the long term

With yields at record highs, buying commercial property through a Sipp could provide a good source of income, experts say.

But the widely-held view is that, while the rate of decline has slowed, values still have further to fall, so investors seeking the bottom of the market are engaging in a risky activity.

Commercial property values have fallen 35 per cent on a total return basis since the market peaked in the summer of 2007, according to IPD, which compiles monthly figures on the sector.

The rate of decline has slowed somewhat, with values falling nearly 9 per cent in the first quarter of this year, compared with 15 per cent in the last quarter of last year.

However, the IPD points out that the fall is still much steeper than the same period last year, when values fell just 4.7 per cent.

Meanwhile, yields have been rising steadily as values have dropped, with initial yields for all property now at 7.7 per cent. For investors seeking income, this could be a positive sign.

“While this momentum in falling rents is a concern for property owners, an implied income return of over 8 per cent must be whetting the appetite of value and income-seeking investors,” says Malcolm Frodsham, research director at IPD.

However, he warned that rents were starting to fall “at quite a rapid rate” and were likely to continue doing so for some time.

Many retail investors remain cautious about investing in commercial property. Funds that sprung up in the boom years of 2006 and 2007 have performed extremely poorly. Some have even imposed restrictions on investors who want to withdraw their money to allow time to sell properties to meet demands for redemptions. “There’s still an element of nervousness about property. It’s very difficult to call,” warns Billy Mackay at AJ Bell.

However, for investors buying commercial property through a pension, the long-term nature of the investment can help toquell fears. “If you’re in for the long term – which most Sipp investors tend to be – for most, the falls in value are not a critical issue,” argues John Moret at Suffolk Life.

Investors who want to opt for a commercial property fund are generally advised to pick one that has a high level of cash and so can snap up properties at bargain prices.

Danny Cox at Hargreaves Lansdown believes the Threadneedle UK Property Fund is the best of the bunch, though he is not advising clients to buy commercial property yet.