The purchase of shares in a private company by a Sipp has attractions but study the risks and technical detail carefully before rushing to action, writes Gayle Murray of Xafinity Consulting.
It is well publicised and commonly understood that one of the principal attractions of a self-invested pension plan (Sipp) is a commercial property purchase, especially the purchase of the member’s business premises. This transaction generates funds for the business and moves the property into a tax-efficient environment, where rental income and tax-free capital gains grow the pension pot.
This remains a popular Sipp investment choice. However, the market is seeing a shift, with many people looking to align their pension funds more closely with business interests via the purchase of company shares.
Investing a Sipp in shares
The first reason is that a share investment may be a ‘good’ investment opportunity; the Sipp’s raison d’être is to accrue a pension pot sufficient to provide an income in retirement and a good investment will help achieve that.
Individuals are being presented with opportunities to invest in companies they have been working with, perhaps as a consultant. In this situation, the Sipp member has no control of the company and may not have the cash funds to buy these shares personally but could use his pension pot to secure the opportunity.
We also see a lot of interest from Sipp members who are looking to invest in their own company shares. Some of the reasons for this include:
Generating business liquidity, allowing it to invest and grow further, perhaps by funding a business takeover.
An alternative to a loan, where cash can be generated without monthly repayments of capital and interest.
A company may be looking to buy a shareholder out and, without the cash funds in the business, the pension fund could facilitate this without the need for a third party to buy the shares.
The main advantage of using the Sipp funds is that as the business grows and the share value increases, the pension fund increases free of capital gains tax.
This type of investment is also being considered for succession planning. Individuals could be looking to save tax efficiently using the pension wrapper then purchasing shares later once, for example, a parent is ready to bow out of the company.
Pension funds cannot simply be passed from one individual to another and transactions via the Sipp must take place at market value. Alternatively, where the company does not have cash to pay pension contributions, the in-specie contribution route could be used to boost pension savings.
Too good to be true?
A few words of caution. There are some attractions where a business prospers. However, equal consideration should to be given to the risks. Ultimately, a business might fail. Remember the old adage of having all your eggs in one basket; as the company fails, so do the retirement savings.
There are other considerations that may make this less attractive; liquidity, for example, where these specialised shares may need to be sold to settle benefits.
Also, the detailed requirements laid down by HM Revenue & Customs concerning in-specie contributions bring their own element of risk to the transaction.
The technical stuff
We are now entering a minefield; there are onerous regulations in place that impact indirectly on this type of investment under a Sipp. These are the ‘taxable property’ regulations, intended to ensure that a Sipp does not invest in residential property or ‘tangible moveable property’.
Unlisted share purchases could easily trigger a breach of these regulations, which would lead to tax charges not only for the scheme administrator but also for the Sipp member as an individual. Where an individual, alone or with connected parties, owns more than 20% of the company, it becomes more difficult to avoid breaching the regulations because the taxable property exemptions apply to the shareholding percentage.
There are other exemption criteria that could allow the purchase and which should be looked at closely against the company structure and asset holdings.
In most cases, an accountant should be involved in looking at the investment not only to establish its prudence but to also provide comfort to the Sipp provider (as trustee and scheme administrator). Any exemption criterion must be applied throughout the life of the investment; it is not a one-off test at outset. This brings further continuous monitoring requirements.
Pension scheme liberation should not be forgotten; significant tax charges could be imposed if an investment is deemed ‘trust busting’. Using pension funds to prop up a failing company is not acceptable and could be deemed trust busting.
Good idea or not?
As with any investment, unlisted shares have their pros and cons and depend on personal circumstances. There are complex regulations that indirectly govern this investment class, which is why a number of Sipp providers do not allow unlisted shares.
The key is clarity around the client’s circumstances and personal objectives, coupled with a product provider that understands the issues.
Professional advice should be sought and combined with thorough due diligence on the business; adviser and client need to go into this with their eyes open. But if the circumstances are right, this could present a great opportunity.
Gayle Murray is technical and projects manager at Xafinity Consulting.