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HMRC internal manual

Pensions Tax Manual

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HM Revenue & Customs
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Investments: taxable property: direct holdings

Glossary PTM000001
   

 

Direct holding of taxable property - introduction
Occasions where tax could be charged on direct holdings
Where tax charges apply to direct holdings
Amount and timing of charges on acquisition/improvement/conversion of directly held property
Where an interest in taxable property is acquired under a lease
Taxable property as loan security
Where the property is acquired for less than market value
Where a property is improved/converted or adapted
Apportioning unauthorised payment to members arrangement
Amounts chargeable on income/deemed income from direct holdings
Amounts chargeable on gains from direct holdings

 

 

Direct holding of taxable property - introduction

 

Paragraph 14 Schedule 29A Finance Act 2004

A scheme holds an interest in property directly where:

  • it holds the property or any estate, interest, right or power in or over it under the law of the relevant country or territory,
  • it has the right to use, or participate in arrangements relating to the use of that property or a description of property to which that property belongs under the law of the relevant country or territory,
  • it has the benefit of any obligation, restriction or condition affecting the value of any estate, interest, right or power in or over the property under the law of the relevant country or territory.

An interest in property is held directly if the scheme, whether jointly, in common or alone, is entitled to receive payments derived directly or indirectly from it. In other words, where the property is held by the pension scheme rather than indirectly through a vehicle (such as a company).

Payments under contracts can be direct holdings

This covers the type of situation where a scheme holds a contract and payments under that contract are derived from underlying property. In these cases the legislation ignores the contract and deems the pension scheme to be directly holding the underlying property.

Probably the most common types of contract this will affect are certain types of insurance contract, such as personal portfolio bonds, where payments are directly linked to underlying assets. These rules mean that in determining what assets a pension scheme holds this type of insurance contract is ignored.

So, for example, if the pension scheme holds an insurance contract and the payments made under that contract derive from some underlying assets the pension scheme will be deemed to be holding those assets directly. It should be noted that this deemed holding will only apply for the tax charges relating to taxable assets and for no other purpose.

Certain payments under contracts are not direct holdings

The provisions in the above paragraphs do not apply if either:

  • the pension scheme or arrangement (either alone or together with associated persons) is not entitled to receive payments representing 10% or more of the market value of or the income from the underlying property, or
  • the pension scheme that holds the rights under the policy does not do so for the purposes of enabling a scheme member or a person connected to a member to occupy or have personal use of the underlying property.

In this page the term “associated person” in relation to a pension scheme means:

  • any member of the pension scheme,
  • any person connected with such a member,
  • any arrangement (under that or another pension scheme) relating to a member of the pension scheme,
  • any arrangement (under that or another pension scheme) relating to a person connected to such a member,
  • any associated pension scheme, see below.

In the above a pension scheme is associated with another pension scheme if members representing at least 10% by value of one pension scheme are members of the other pension scheme or connected with such members.

The percentage by value represented by a member of a pension scheme is AM/AA x 100.

AM is an amount equal to the aggregate of the amount of the sums and the market value of the assets held for the purposes of an arrangement under the pension scheme relating to the member.

AA is an amount equal to the aggregate of the amount of the sums and the market value of the assets held for the purposes of the scheme.

In this page “associated person” in relation to an arrangement means:

  • the member of the pension scheme to which that arrangement relates,
  • any person connected with such a member,
  • any arrangement (under that or another pension scheme) relating to a member of the pension scheme to which that arrangement relates,
  • any arrangement (under that or another pension scheme) relating to a person connected to such a member.

Connected person means as defined in section 993 and 994 of Income Tax Act 2007 see PTM027000.

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Occasions where tax could be charged on direct holdings

Section 174A and Part 4 Schedule 29A Finance Act 2004

An unauthorised payment will arise when an investment-regulated pension scheme uses funds to acquire, improve, convert or adapt taxable property. This is designed to remove the tax relief granted on those funds when they are invested in taxable property.

If taxable property is gifted to the scheme no acquisition tax charges apply. This is because there has been no tax relief given in relation to that acquisition. If however the gift is treated as a tax relieved contribution that amount will incur acquisition tax charges.

If an investment-regulated pension scheme holds an interest in property which is not taxable property and this then becomes taxable property without any conversion or adaptation works the pension scheme is treated as acquiring an interest in taxable property.

This will most commonly happen due to a change in occupation or in the use made of the property.

Example

The pension scheme may hold residential property that is let out to a person who is required to occupy it as a condition of his employment. If subsequently the property is let out to a person who is not in that position it will be deemed to have been acquired at that point and an unauthorised payment will arise.

A scheme sanction charge (See PTM121000) will arise when an investment-regulated pension scheme receives income or is deemed to receive income from taxable property.

A scheme sanction charge will arise when an investment-regulated pension scheme disposes of one or more assets consisting of interests in taxable property that give rise to chargeable gains.

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Where tax charges apply to direct holdings

If an investment-regulated pension scheme acquires a direct holding in taxable property this creates an unauthorised payment on the member for the purposes of whose arrangement the property is held. So the member is subject to the unauthorised member payments charge at 40% on the relevant unauthorised payment value. The scheme administrator is liable to the scheme sanction charge, generally an amount of 15% of the value. If certain limits are exceeded the member may also be subject to the unauthorised payments surcharge at 15%. See PTM134000 for further details of all these charges.

Income or deemed income received in relation to the asset is charged to the scheme sanction charge so the scheme administrator is liable to the scheme sanction charge at 40%. See PTM135000 for further details of this charge.

Capital gains on the disposal of assets are charged to the scheme sanction charge so the scheme administrator is liable to the scheme sanction charge at 40%. See PTM135000 for further details of this charge.

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Amount and timing of charges on acquisition/improvement/conversion of directly held property

Where an investment-regulated pension scheme acquires a direct interest in taxable property the unauthorised payment is treated as made when the interest in the taxable property is acquired by the scheme.

The total taxable amount of the unauthorised payment is:

  • the amount of consideration, in money or money’s worth, given directly or indirectly for the interest, plus
  • the amount of any fees and other costs incurred in connection with the acquisition.

Typically this will be the purchase price for the property plus related legal and professional fees and other costs such as stamp duty. But it also covers other acquisitions, for example, by use of an option. If, say, a pension scheme buys an option for £1m that can be exercised to buy a taxable property for £1then the acquisition cost, excluding fees, etc., is £1,000,001, that is the amount of consideration given directly or indirectly. The option constitutes an interest in taxable property.

In most cases it is the actual amount incurred that is charged. However there are two exceptions:

  • if the property is acquired through a transfer from a registered pension scheme that is not an investment-regulated pension scheme it is treated as an acquisition at market value
  • if the property is received by the pension scheme as part of an in-specie contribution (see PTM042100) it is treated as being acquired for the value of that contribution.

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Where an interest in taxable property is acquired under a lease

If an interest in taxable property is acquired under a lease the amount of the consideration for the purpose of working out the taxable amount of the unauthorised payment (see above) is based on a calculation of the capitalised cost of the lease rentals.

The calculation will use the method adopted by Stamp Duty Land Tax (SDLT) to calculate the cost of the acquisition and varies depending upon whether or not the consideration is wholly or partly other than rent. Although based on Stamp Duty calculations there are some differences that are to reflect that this is anti-avoidance legislation, so no relief will be given for some items relieved in SDLT legislation. These are the value of an undertaking by the tenant to repair the property, to pay amounts for service, repairs, maintenance and insurance, any guarantee of rent and any penal rent that may be paid.

Example

Present value of a 20 year lease at £5,000 rent increasing to £7,500 year 6, £9,000 year 11 and £12,500 year 16. So the lease has upwards only increases to market rent at the end of every 5th year.

NPV means - Net Present Value

 

Year Annual Rent (£) Annual NPV (£) Total NPV (£)
       
1 5,000 4,831  
2 5,000 4,668 9,498
3 5,000 4,510 14,008
4 5,000 4,357 18,365
5 5,000 4,210 22,575
6 7,500 6,101 28,677
7 7,500 5,895 34,571
8 7,500 5,696 40,267
9 7,500 5,503 45,770
10 7,500 5,317 51,087
11 9,000 6,165 57,251
12 9,000 5,956 63,207
13 9,000 5,755 68,962
14 9,000 5,560 74,522
15 9,000 5,372 79,894
16 12,500 7,209 87,103
17 12,500 6,965 94,068
18 12,500 6,730 100,299
19 12,500 6,502 107,299
20 12,500 6,282 113,582
Total rent 170,000 NPV 113,582

 

The unauthorised payment is £113,582

 

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Taxable property as loan security

Sections 174A, 179 and Paragraph 32(2) Schedule 29A Finance Act 2004

Where an asset that is taxable property is used as security for a loan from a pension scheme that is an occupational pension scheme and also an investment-regulated pension scheme to a sponsoring employer then putting in place the first charge immediately creates an interest in the taxable property being used as security. From that point the scheme has a right over the property.

Acquiring an interest in taxable property means that the scheme is treated as having made an unauthorised payment. The amount of the unauthorised payment is the sum of:

  • the amount of consideration given for the interest
  • the amount of any fees or costs in connection with the acquisition.

Normally, no consideration would be given for the acquisition of a first charge over taxable property. However, there may be fees or costs to pay to put the first charge in place. If so, any sums paid by the pension scheme will give rise to an unauthorised payment.

If, at a later date the employer defaults on the loan, the scheme may call in its charge. Enforcement of a charge over the property will usually lead to the scheme obtaining additional rights, such as a right of occupation. This acquisition of a further interest in the taxable property will create an unauthorised payment based on its market value.

Charging Orders

A charging order is an order of the court applied for by a creditor. Putting in place the charging order immediately creates an interest in taxable property. From that point the scheme has a right over the property and there is no essential change in the scheme’s interest when the charge is enforced and payment is received.

Normally no consideration, directly or indirectly, would be given for the acquisition of a charging order over taxable property. However there may be fees or costs to pay to obtain the charging order. If so, any sums paid by the pension scheme will give rise to an unauthorised payment.

Amount of tax charge

Guidance on the amount of the tax charges on the acquisition of directly held taxable property is described above.

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Where the property is acquired for less than market value

Where an investment-regulated pension scheme acquires a direct interest in taxable property for less than its market value and immediately before the acquisition the interest was held by a registered pension scheme which was not an investment-regulated pension scheme the unauthorised payment amount is to be the market value of the interest at the time it was acquired. This is to ensure that any property transferred from a non investment-regulated pension scheme is subject to the unauthorised payments charge. Market value means in accordance with section 272 Taxation of Chargeable Gains Act 1992 - the price which assets would reasonably be expected to fetch on a sale in the open market.

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Where a property is improved/converted or adapted

Section 174A and Paragraphs 38 to 40 Schedule 29A Finance Act 2004

Where an investment-regulated pension scheme holds an interest directly in taxable property and the property is improved an unauthorised payment is treated as made at the time when a payment is made in connection with the improvement works and the total taxable amount is the amount of the payment.

Where an investment-regulated pension scheme holds an interest in property which is not taxable property and it becomes taxable property as a consequence of any conversion or adaptation works it is treated as the acquisition of an interest in taxable property and an unauthorised payment arises.

The unauthorised payment is treated as made at the earliest of the following:

  • the time when the conversion or adaptation works are substantially completed
  • where the property becomes a dwelling or suitable for use as a dwelling before the conversion or adaptation works are substantially completed and the property is disposed of, the time when the interest in the property ceases to be held by the pension scheme,
  • where the property becomes a dwelling or suitable for use as a dwelling before the conversion or adaptation works are substantially completed and the property is not disposed of, the end of the period of three years beginning with the date when the first payment was made in connection with the conversion or adaptation works.

The total taxable amount of the unauthorised payment depends upon whether the conversion or adaptation works began before or after twelve months from the date the interest in the property was acquired by the pension scheme.

If they began within the twelve months period the amount is the sum of the following:

  • the amount of consideration for acquisition of the interest determined on the relevant basis set out above, and
  • the development costs.

If they began after the end of that period the amount is the sum of the following:

  • the relevant market value, and
  • the development costs.

The relevant market value means:

  • the market value of the interest in the property held by the scheme, or
  • if the interest in the property is a lease at rent, the amount of consideration that would be treated as given by the scheme for the lease using the valuation basis set out above (under the heading ‘Where an interest in taxable property is acquired under a lease’) if it were assigned at that time.

The development costs means the total cost of the conversion or adaptation works at the time when the unauthorised payment is treated as made. This is subject to the following two paragraphs.

Where, at that time, an amount will be payable, or will cease to be payable, for the works only if some uncertain future event occurs the development costs are to be determined on the assumption that the amount will be payable or, as the case may be, will not cease to be payable.

Where, at that time, an amount payable for the works depends on uncertain future events or cannot otherwise be ascertained that amount is to be determined on the basis of a reasonable estimate.

Where a reasonable estimate is made and the actual amount is later ascertained at a higher sum a further unauthorised payment of the amount of the difference is treated as made at the time of the ascertainment.

Where any interest directly held in taxable property by an investment-regulated pension scheme is held jointly or in common for more than one scheme member the amount of any unauthorised payment is to be apportioned between them on a just and reasonable basis.

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Apportioning unauthorised payment to members arrangement

Paragraph 45 Schedule 29A Finance Act 2004

An item of taxable property will relate to a person’s arrangement if that property is held by the scheme for the purposes of that arrangement.

Whether an asset is held for the purposes of an arrangement will depend firstly if it is attributed to that arrangement under the rules of the scheme.

If the rules do not directly attribute the assets, perhaps because they are held in a common trust fund, then these will be attributed to a member on a just and reasonable basis which will depend upon the facts related to the pension scheme.

Some schemes will notionally hypothecate assets to arrangements and therefore it may be appropriate to allocate the assets to those arrangements on a just and reasonable basis.

If the assets are genuinely held in common for all arrangements then these will be allocated to arrangements on a pro rata basis.

Some pension schemes may hold assets which are surplus to requirements and are specifically not allocated to arrangements. Unless such assets are used for the purpose of management or administration of the scheme they will be allocated to arrangements on a pro rata basis.

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Amounts chargeable on income/deemed income from direct holdings

Sections 185A to 185C Finance Act 2004

In addition to the other tax charges the scheme administrator will be liable to tax on the greater of profits received or a deemed income in respect of taxable property. These are scheme chargeable payments and the scheme administrator is liable to the scheme sanction charge at 40%. The deemed income will be based on 10% of the value of the taxable property on acquisition increased each year by RPI. This very broadly correlates with long term property trends.

An investment-regulated pension scheme is treated as having made a scheme chargeable payment where at any time during the tax year it directly holds an interest in taxable property.

The amount of the scheme chargeable payment is the higher of:

  • the total amount of profits received in the tax year from the interest in the property, and
  • 10% of the deemed value of the interest in the property for the tax year.

If the property is not taxable property for the whole year this is the proportion for the period when it is taxable property.

Where the scheme does not hold its direct interest in the property by virtue of a lease of residential property the deemed value is the cost of the property plus any further costs of improvements or development. This is increased by inflation each year.

The deemed value is arrived at using the following formula:

(MV + UP) x (1 + RPI)

MV is the opening market value. This is determined as follows:

in the tax year the first interest in the taxable property is acquired etc this is the market value immediately after it first becomes taxable property.

in any later tax year it is the deemed value of the immediately preceding tax year.

UP is zero unless there has been any improvement to or further acquisition of an interest in the taxable property in the tax year. In which case it is the total of any unauthorised payments treated as made by the pension scheme in respect of the improvements or further interests acquired.

RPI is the percentage increase in the retail prices index (expressed as a decimal) from the first day in the tax year that the scheme held the taxable property interest and the last day of that tax year. If the index falls the figure is 0.

If the property is not taxable property for the whole year the deemed profit is apportioned to take into account only the period when it is taxable property. See the example below.

If the property is held on a lease the value of MV is taken to be the value of the lease assuming it was granted when it first became taxable property, for a term of 50 years payable at a full commercial rent.

Example of amounts chargeable on income/deemed income

The XYZ investment-regulated pension scheme acquires a taxable property for a member on 1 September 2014 at a total cost of £110,000 when its market value is £100,000. It is let to a tenant at an initial rent net of expenses of £7,000 pa. The net rent increases in 2015/16 to £10,500. The RPI increase from acquisition to 5 April 2015 is 5.3%. The RPI increase for 2015/16 is 6.2%.  (Both RPI figures are used for illustrative purposes only.)

2014/15

The deemed value is (£100,000 + 0) x (1 + 0.053) = £105,300

Deemed income is £105,300 x 10% x 217/365 = £6,260

(The scheme only holds the taxable property for 217 days so the deemed income is apportioned)

Actual net income is £7,000 x 7/12 = £4,083

The scheme chargeable payment is the deemed net income received of £6,260 (the deemed income amount is greater than the actual net income received).

2015/16

The deemed value is (£105,300 + 0) x (1 + 0.062) = £111,828

Deemed income is £111,828 x 10% = £11,182

Actual net income is £10,500

The scheme chargeable payment is the deemed net income received of £11,182 (the deemed income amount is greater than the actual net income received).

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Amounts chargeable on gains from direct holdings

Sections 185F and 185G Finance Act 2004

In addition to the other tax charges the scheme administrator will be liable to tax on any capital gains arising on disposals by an investment-regulated pension scheme relating to taxable property. These are scheme chargeable payments so the scheme administrator is liable to the scheme sanction charge at 40%.

Where taxable property is gifted to the scheme there are generally no acquisition tax charges, see ‘What are the occasions of a tax charge on direct holdings?’ above. But the tax charges on gains do apply to this taxable property.

The calculations broadly follow the principles applying under Taxation of Chargeable Gains Act 1992 legislation and are made on the same basis as if the scheme were a UK resident and domiciled person but no claim can be made for the annual exempt amount. Guidance on specific points can be found in the Capital Gains Manual

Calculations are made for each tax year. If a pension scheme makes a series of disposals, those that generate losses may be set against those generating gains and only the net amount of gain is the scheme chargeable payment. Unused losses are lost and cannot be carried forward or backward to other tax years. Losses cannot be claimed in respect of disposals of any scheme assets that are not taxable property.

Taper relief will be given at the rate applicable to non-business assets.

This applies equally to any gains that may arise on property that may otherwise qualify for business assets taper rate, for example some furnished holiday lettings.

Different rules apply to taxable property that is tangible moveable property that is a wasting asset. Any loss arising on disposal of such assets may only be set against gains arising from other assets of that category in that same tax year.

Where an asset only becomes a taxable property asset sometime after its original acquisition by the scheme it is treated as acquired at the time it became a taxable asset and its cost is the amount of unauthorised payment treated as made by the pension scheme at that time.

If an asset is not a taxable asset throughout the time it is held by the scheme the gain on its disposal is to be reduced on a time basis to the period when it was a taxable asset.

A scheme disposes of an asset when it ceases to hold it and disposes of a part if it ceases to hold any part of it.