Limited companies may be liable to a Corporation Tax bill when selling commercial property. Similarly, an individual may incur a Capital Gains Tax (CGT) liability on corresponding gains.
However, registered pension schemes such as self-invested personal pensions (SIPPs) or small self-administered schemes (SSASs) are exempt from CGT upon the sale of a commercial property; held as an asset of the scheme. Despite the immediate costs incurred in selling the commercial property to the scheme trustees, it might be beneficial to use a pension vehicle to shelter future gains on commercial property from tax.
Let’s look at this using a worked example:
A company buys a commercial property to run its day-to-day business from for £500,000 (including various expenses such as legal fees). Soon after, the three directors of the company express concerns on how to raise cash to invest in the company with their accountant. The accountant warns that the directors could face a potentially sizeable tax bill when the property is eventually sold. Following the accountant’s recommendation, the directors decide to establish a SSAS with the intention of using their pooled pension wealth to buy the property and inject cash into the business.
By the time the SSAS has been established, initial employer contributions made and transfers-in from existing schemes completed - the market value of the property has risen to £550,000 (partly attributable to the company’s tenancy). Since connected party transactions must be conducted on an ‘arm’s length’ basis, this is the price the SSAS pays for the property, partly financed by a mortgage.
The company has therefore received a cash injection of £550,000. However, 19% of the company’s capital gain on the property, (i.e. £9,500), is payable in Corporation Tax. The trustees of the SSAS have also incurred set-up and legal fees of £4,000, giving the sale and purchase transaction a total initial cost of £13,500.
Some years later - when the directors wish to retire and sell the company - they sell the property for its current value of £825,000 (please note that an increase in a property’s value over time is not guaranteed). Since it is held within a registered pension scheme, the trustees are exempt from CGT on the gain made, leaving the entire amount available for the provision of retirement benefits.
Forgoing the pension route
If the directors had initially given in to their reluctance to trigger a tax charge early on, and decided that using their pension wealth to acquire the property was unnecessary (especially given their company already owned the property outright), the position would have been quite different. While they would have avoided the above fees and immediate tax bill totalling £13,500, when their eventual retirement came and the property was sold for £825,000,
Had they instead owned the property personally, the situation would have been similar, except that CGT would have applied at the relevant rates.
This case is a simplified example of how absorbing moderate tax and administration costs upfront can mitigate much larger expenses further down the line.