How can a SIPP make a loan to an unconnected party?
21 February 2020
Stephen McPhillips, technical sales director, Dentons Pension Management, uses a case study to explain.
As many readers may be aware, pensions simplification on ‘A-Day’, 6 April 2006, brought some welcome levelling of the playing field between self-invested personal pensions (SIPPs) and small self administered schemes (SSAS). For example, it brought with it a common set of rules around contributions, it made property purchase identical across each vehicle including pension scheme borrowing rules, and it set an overall limit of tax advantaged pension scheme saving in either pension wrapper through the introduction of the lifetime allowance (LTA).
However, some key differences remain between SIPP and SSAS and these can drive the advice process one way or another; SIPP or SSAS.
For those familiar with SSAS, it will be recognised that a SSAS can lend monies to the sponsoring employer, or an associated company, participating in the SSAS. That lending has to take place within strict terms imposed by HMRC. These strict terms are in place because of the connection between the parties and the resulting danger of a loan taking place on uncommercial terms.
SIPPs, on the other hand, cannot lend monies to connected parties – either directly or indirectly – and we have a key differentiator between the two products here. It may be something of a surprise to learn that a SIPP member would lend funds from his or her SIPP to an entity that is not connected with them in any way, but it can, and does, happen.
How do SIPP loans work?
A fundamental factor in SIPP lending is the unconnected nature of the borrower. This, in turn, means that the lending can take place on terms quite different to those that would apply if the borrower was a connected party, such as with a SSAS loan to an employer. It stands to reason that the loan should be granted on fully commercial terms because the lender and the borrower are not connected with each other. There is therefore no need for HMRC to impose a pre-determined set of terms upon the parties; normal open-market forces should be at work.
It is absolutely critical that the entity borrowing from the SIPP can always be identified. If the borrower cannot be properly identified, how can the SIPP provider be certain that SIPP monies do not find their way to a connected party and hence result in an unauthorised payment taking place? Whilst some lending platforms do allow for the end-borrower to be identified, some do not and those that don’t may find that SIPP providers will not allow access to that lending platform through their SIPP products.
Having satisfied the requirement that the borrower is a truly unconnected party, the next considerations tend to be around the amount of loan to be granted, the interest that will be generated on the loan and the level of security being offered to the SIPP as lender.
As we have already covered, the loan terms do not need to replicate those that would apply to SSAS lending, and frequently they don’t. For example, a SIPP loan could be granted on an unsecured basis. Contrast this with SSAS loans which must be secured by a First Legal Charge. The term of a loan may be for more than five years, unlike SSAS, and the interest rate would be agreed between the parties. The interest rate is likely to be reflective of a number of factors, including:
Unlike in a SSAS, there is no HMRC maximum limit on the amount of SIPP funds that can be loaned to an unconnected party. So, in theory, a SIPP member could lend 100% of his or her funds to the borrower, instead of the 50% maximum that applies to SSAS. In practice, however, some SIPP providers will place a restriction on such lending within their SIPPs because of the risk that they may represent. That restriction may vary depending on whether the loan is secured or unsecured, and the nature of the security itself.
Case study – SIPP loan to an unconnected party
John and Carl have been friends for many years. John is a senior partner in a sizeable provincial law firm and Carl runs a property development and construction business. John knows the quality of Carl’s work and has been impressed with it over the years they have known each other.
Carl informs John that his limited company business is nearing the completion of two luxury apartments, but that it has encountered a temporary cash flow issue. In turn, this is meaning that Carl cannot finish the construction of the apartments to get them onto the property market. Carl tells John that it will cost around £125,000 to complete the projects.
John knows the local property market very well in his capacity as an experienced conveyancing lawyer. He is confident that, once complete, the apartments will sell very quickly.
John speaks to a longstanding financial adviser connection of his to ascertain whether he can assist in any way using his accumulated SIPP pension pot of £375,000. A joint meeting then takes place, at which John, the adviser and a trusted SIPP provider connection discuss the options.
SIPP purchase / part purchase of the apartments is ruled-out because they are residential, and hence taxable if owned by the SIPP. SIPP purchase of shares in Carl’s business is ruled-out because John does not want to interfere in the day to day running of Carl’s business. Both of these options would have provided cash to Carl’s business.
Having obtained confirmation that there is no legal connection between John and Carl, the trusted SIPP provider confirms that John’s SIPP could lend monies to Carl’s business. A loan of £125,000 is agreed between the parties and John’s SIPP obtains a Legal Charge to secure the lending. Within around a year, the apartments are completed, sold and the loan is fully repaid with 8% interest into John’s SIPP.