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Tax Implications of Investing in Property Using Pension Funds

Published by Susan Basnet
Posted Date: May 17, 2024 , Modified Date: May 28, 2024
Categories: Pension Scheme

Acquiring commercial property through pension funds has become increasingly popular due to its tax advantages. However, it’s important to note that pension funds are not entirely exempt from taxation. While rental income received by pension funds is typically exempt from income tax, certain taxes, like SDLT, are applicable when making such investments.

In this article, we’ll explore these taxes, commencing with stamp duty land tax.

Stamp Duty Land Tax (SDLT)

Stamp Duty Land Tax (SDLT) is generally payable on the purchase or transfer of property in the UK where the amount given is above a certain threshold. There are no special SDLT rules for pension funds; pension funds are within the scope of SDLT. Pension funds must account for SDLT for the property exceeding the SDLT threshold of £250,000 for residential and £150,000 for commercial buildings or mixed properties (i.e. commercial and residential properties), like normal transactions.

This means that SDLT will be due where there is chargeable consideration for the transaction involving pension funds. Where the consideration exceeds the SDLT threshold, they must submit an SDLT1 showing the chargeable consideration and make the payment within 14 days of the ‘effective’ transaction date, which is generally the transaction completion date. Where the transaction amount is less than £40,000, an SDLT return would not be necessary.

When a pension fund acquires a residential property, the following rates would apply:

Consideration

SDLT  Rate

Up to £250,000

Zero

The next £675,000 (the portion from £250,001
 to £925,000)

5%

The next £575,000 (the portion from £925,001
 to £1.5 million)

10%

The remaining amount (above £1.5 million)

12%

Likewise, the following rates would be applicable when a non-residential property is acquired via pension funds:

Relevant Consideration

SDLT  Rate

Up to £150,000

Zero

The next £100,000 (the portion from 150,001
 to £250,000)

2%

The remaining amount (above £250,000)

5%

For Example, 

A pension fund acquires a non-residential property, paying a consideration of £500,000. In that scenario, the SDLT payable would be computed as follows:

  • First £150,000 @0% - £0
  • The Next £100,000 @2% - £2,000
  • Remaining £250,000 @5% - £7,500

Therefore, the final SDLT bill would amount to £9,500.

Income Tax and Capital Gains Tax (CGT)

As previously mentioned, the rental income received on the pension investments is tax-free, which is why a general practice is to buy a property via pension funds, pay rent to the pension fund and save the rent that would have otherwise been lost to a third-party landlord.

Income Tax and Capital Gains Tax (CGT)
Likewise, Capital Gains Tax (CGT), a tax charged on the disposal of assets whose value has appreciated, is also exempt for pension funds, providing a huge relief for pension fund holders.

Value Added Tax (VAT)

A pension fund operates under VAT rules like regular businesses. It may register for Value Added Tax (VAT) and reclaim input VAT. Like any other VAT-registered businesses, pension funds must file regular VAT returns.

It is a general practice for the pension funds to register for VAT and ‘opt to tax’ due to two main reasons:

  • One common reason for registration is when a pension scheme buys a property from a vendor who has opted to tax. In such cases, VAT is paid on the purchase price. If the pension fund is VAT registered and opts to tax the property, it can claim back the VAT paid to the vendor from HMRC.
  • Another scenario prompting registration is when significant development work is done on a property held by a pension scheme that wasn’t previously opted to tax. Contractors charge VAT on construction work, requiring registration to recover these costs.

Once registered and ‘opted to tax on a property’, the pension fund must charge VAT on all future rental income and any subsequent sale.

However, this could pose a problem for tenants who can’t recover VAT, either because they’re not registered or because they make exempt supplies. They could face a 20% increase in rental payments, potentially making the property less attractive commercially. However, VAT-registered tenants should be able to reclaim the VAT charged on rents, offsetting any issues caused by opting to tax.

Investing in Property using Pension Funds

An Example, 

Let’s look at how these investments work through a simple example involving John and his business, ABC Company. We’ll see how effective planning can bring benefits in this scenario. Currently, his company pays an annual rent of £30,000 for its business premises. Given the substantial amount spent on rent, John is exploring options to utilise these funds more effectively. With £250,000 held in his pension fund, he is considering investing these funds to purchase a commercial property where his company can operate.

Subsequently, John can utilise his pension fund to acquire the commercial property. Subsequently, his company will operate from this new premises. The company will continue to pay rent, this time to John’s pension fund, amounting to £30,000 annually. Importantly, this rental income will accrue tax-free within the pension fund. Furthermore, for John’s company, this rent remains a tax-deductible expense.

Conclusion

Opting to invest in property through pension funds presents a compelling avenue for tax-efficient wealth accumulation, as evidenced by the exemption from Income Tax and Capital Gains Tax on rental income and property disposals.

While Stamp Duty Land Tax and Value Added Tax considerations may apply, the overall tax benefits outweigh the associated costs, making property investment through pension funds an attractive option for savvy investors seeking long-term financial growth and security. However, careful planning and professional guidance are imperative to navigate the complexities of tax regulations and optimise returns.

Need expert advice on investing using Pension Funds?

Contact us today for efficient and
hassle-free assistance.

Susan Basnet
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