For Use By Financial Advisors Only
This note is for general guidance only and is based on our understanding of the current position of the rules and legislation relating to residential property. Specific advice should be sought in respect of each individual case to ensure that the requirements of HMRC and relevant legislation are being met.
Residential Property in Registered Pension Schemes Background
Registered Pension Schemes cannot normally own residential property, directly or indirectly, without incurring substantial tax charges. Under some circumstances, however, it is possible for a pension scheme to either obtain residential planning permission, or part develop land or existing commercial properties with a view to producing a return on its investment. The key challenge is having an exit strategy formulated prior to the property becoming residential.
Residential Property Summary
- Residential property is a form a Taxable Property. A direct or indirect holding will, therefore, result in a heavy tax penalty for a pension scheme.
- Residential property is property that is capable of being used as a residence. There is no list of requirements that further defines this. Instead, a common sense approach has to be adopted.
- Land with planning permission for residential use is not residential property. Thus Trustees can consider whether obtaining residential planning permission on land might present them with an investment strategy that provides a capital return for the pension scheme.
- Development of commercial property or land into residential is possible provided Trustees consider carefully their exit strategy. Property must be sold before it becomes residential property and they need to consider to whom the property could be sold in an incomplete state.
- Trustees need to work closely with the main contractor in order to ensure that any build stops short of being residential property. The contractor should have an expert understanding of local planning and building regulation law to ensure that development ceases at the appropriate stage.
Definition of Residential Property
The principal definition of residential property is ‘a building or structure that is used or suitable for use as a dwelling’.
As such, land even where it has planning permission is excluded from this definition. Some care needs to taken, however, where land is part of the garden or grounds of a residential property, as in that instance it is classed in the same fashion – i.e. residential.
Similarly, commercial property that has a change of planning use granted does not immediately become residential property. Some types of ‘job-related’ residential property can possibly be accepted, provided that the tenant is not connected to the Scheme members, and occupancy is a condition of employment e.g. a caretaker for a commercial property residing on the premises.
It follows that a pension scheme can undertake a certain level of development to land or a commercial property provided that it does not ever reach the stage of becoming residential property. HMRC provide some guidance for this in that they indicate that the point at which a property in the UK is classed as residential is when the certificate of habitation is issued.
This is not a definitive position, however, as the property may be classed as residential prior to a certificate being obtained. Thus if the property meets the HMRC definition of residential property, irrespective of a certificate being obtained, tax charges could still apply.
If a pension scheme is considering development, the key element it will need to deal with answer prior to commencing work is the exit strategy. If a property must be sold prior to becoming residential, it is very unlikely it could be sold to the retail market, and instead an ‘intermediary’ vehicle will need to be used. This could be the pension scheme member personally, their company, or another developer who might then complete the project to obtain their own profit.
Cessation of Works
Given the fact that defining residential property will vary depending on the project, it is vital that the Trustees rely on the expertise of the main contractor in determining the point at which all work should cease. The contractor should be in an ideal position to determine, based on their experience of local planning laws and building regulations, at what stage a property would be considered residential. In any event, the Trustees must be absolutely clear as to when works should cease in order to avoid any potential tax charges.
One other consideration is whether the transaction could be judged likely to meet the ‘badges of trade’. Short term profiteering might be considered as a form of trade, and thus the profits might become taxable. Specialist advice may need to be sought in that instance.