Principles, Pitfalls and Practicalities

Background

Much has been written in the specialist pensions press and elsewhere about transferring assets to a pension scheme in lieu of making a cash contribution under HMRC's regulations that came into force on 6 th April 2006– “In-Specie Contributions”. On the face of it this is a very simple proposition, a member, an employer or third party simply transfers an asset to a pension scheme as a contribution and benefits from tax relief. However, for the unwary there are significant pitfalls and HMRC published guidance on the subject is not explicitly clear. Therefore, anybody thinking of making an in-specie contribution should take specialist advice.

The following is an outline of key aspects of making in-specie contributions to which those wishing to make such contributions and their advisors should have regard.

Contributions and Tax Relief

To qualify for full tax relief an in-specie contribution like any other has, together with any other contributions to any other pension scheme, to be within within the overall Annual Allowance which for the tax year 2008/09 is £235,000 per member. Furthermore, a member's personal contributions, including contributions made to any other pension arrangement, must no more than 100% of the member's earnings for the tax year. It should not be forgotten that member contributions also count towards the Annual Allowance.

An in-specie contribution made by an employer for the benefit of a member is treated as gross for tax purposes. Therefore, if an employer transfers an asset worth £100,000 to a pension scheme the contribution is £100,000.

However, a contribution by a member or a third party for the member's benefit is treated as a net contribution after the deduction of tax at the basic rate of 20%. Thus, if a member transfers an asset of £100,000 to his pension arrangement, the contribution is £125,000 gross and it is this figure that would count toward the Annual Allowance and would have to be below 100% of the member's earnings when all other contributions are taken into account for that tax year. The administrator recovers the basic rate tax of £25,000 and a higher rate tax payer can recover additional tax on submission of the member's Self-Assessment Return.

Contributions Must Be “Monetary”

It is clear, therefore, that in-specie contributions are for tax purposes treated in the same way as cash contributions equal the value of the asset being transferred. So, where do the problems lie? The principal problem is that HMRC does not recognise in-specie contributions per se. This stems from the fact that S188 of the Finance Act 2004 refers to “contributions paid”. In HMRC's view this means that any contribution must be expressed in a “monetary form”. Therefore, an employer or individual cannot simply say “this asset is being transferred to the pension scheme as a contribution”. It is HMRC's contention that to transfer an asset to a pension scheme in lieu of a cash contribution a debt expressed in monetary terms must be created first which is settled by the transfer of the asset.

Creation Of A Debt

To create the debt there has to be an irrevocable commitment by the employer or the individual to make a monetary contribution. The instrument that creates the debt must be enforceable in law and be put in place before the transfer of the asset takes place. Therefore, it will be prudent to ascertain the exact market value, in accordance with HMRC Regulations, of the asset before the debt is created. Otherwise, if an employer or individual proposes to make an in-specie contribution by the transfer of an asset which is believed is worth say £100,000 and a monetary debt is created based on that assumption but in the event the asset is valued at only £80,000, there will be a shortfall of £20,000. That shortfall will have to be satisfied by way of a cash contribution or the transfer of further assets to fully discharge the debt.

A serious problem could arise if for any reason it was not possible to complete the transfer of the asset to the Trustees. For example, if when going through the normal due diligence for the transfer of a property a flaw in the title or environmental risk issues were found this could prevent responsible Trustees from accepting the asset in settlement of the debt. This would leave the party making the contribution with the problem of having to find some other acceptable asset to transfer or making the contribution in cash.

Date Of Contribution

Another issue is the question of the date the contribution is paid. The date the debt is created is not the date the contribution is deemed to be paid, it is the date upon which the debt is settled. In the case of property this will be the date of completion of the transfer and in the case stocks and shares the date a “contract” for the purchase of the shares is agreed between the transferor and the trustees.

As there can be a delay between the date the debt is created and the date it is settled other problems can arise. If a debt is created in one tax year or in the case of a contribution made by an employer in an accounting year, in anticipation of getting the relevant tax relief in the same year the debt is created but the transfer of the asset is not completed until the subsequent year, the contribution will not have been paid until that subsequent year. The result will be that anticipated tax relief is not received when expected and the Annual Allowance and/or personal allowance might be exceeded with adverse tax consequences.

Is The Asset Suitable?

Finally, employers and individuals considering making in-specie contributions to their registered pension scheme should not assume that the Trustees and administrators of the scheme will accept the asset in question. There maybe reasons why this is not possible, for example, a flaw in the title. Therefore, a debt should not be created without obtaining the prior agreement in principle of the Scheme Trustees and administrators to the proposed transaction. It would also be prudent for the parties to enter into some form of agreement or contract to acquire the asset to be transferred in-specie. The principal assets that are likely to be transferred in-specie to pension schemes are property and stocks and shares quoted on a recognised exchange.

The following is a summary of the key steps for transferring such assets as in-specie contributions.

Property

• Members and Trustees/Scheme Administrators to agree in principle.
• Obtain an independent value of the property having regard to whether or not there are any existing leases or tenancy agreements in place.
• Instruct lawyers to undertake the usual due diligence including obtaining an environmental risk report to establish there is no reason why the Trustees cannot accept the transfer of the property.
• Create the enforceable debt for the payment of a contribution equal to the monetary value of the property.
• Put in place a purchase/sale agreement between the transferor and the Trustees. The “consideration” should be expressed as the settlement of the particular debt.
• Complete the transfer of the legal title to the property in the same tax or accounting year as the debt is created.

Quoted Stocks and Shares

The transfer of stocks and shares and unit trusts present their own unique problems. This because HMRC require the transaction to be at “arms length” and therefore the investment must be valued in accordance with HMRC Regulations. For stocks and shares quoted in the Stock Exchange Daily Official List (SEDOL), the “quarter up” basis must be used. However, SEDOL prices are not published until the day after the day of dealing. By contrast, the bid and offer prices for unit trusts can be obtained on the same day the debt is settled.

If a contribution of a given number of ordinary stocks and shares of shares is to be made, it will not be possible to establish with certainty their value for the purposes of settling the debt. For example, if a debt is created equal to the value 1,000 shares in YZCO Ltd at yesterday's closing price and on the day of the agreement to buy and the settlement of the debt the price falls there would be a shortfall. If the person is not transferring all the shares owned, an alternative is to agree to transfer shares of a value equal to the debt. In either case, the person making the contribution must have sufficient resources to make up any potential shortfall and care should be taken when entering into such transactions in times of market volatility.

The suggested procedures are:

• Members and Trustees/Scheme Administrators to agree in principle.
• Ensure that the transferor is the registered owner of the investment in question and has the relevant documents and title.
• Obtain a valuation for the investment for creating the debt.
• Establish the irrevocable debt.
• Enter into a sale/purchase agreement (contract).
• Obtain a valuation of the investment for date of contract.
• Complete the transfer of the asset in the same tax or accounting year as the debt was created.

Alternatively, a temporary bank loan can be obtained to enable a cash contribution to be made which is used to purchase the shares. For what is likely to be a relatively modest amount of interest a lot of potential problems can be avoided.

Other Issues

Any transfer of an asset to a pension scheme is a disposal for capital gains tax (CGT).

For quoted investments, the disposal for CGT is on and at the value on the date of the contact and this is also the date the debt is settled and therefore date the contribution is paid.

As to property transfers, the date of the sale agreement/contract is the date of disposal for (CGT) but the date of completion of the transfer is the date that the debt is settled and that is the date the contribution is made. So it is possible to have a disposal for CGT in one tax year and the date the contribution is made in the subsequent year.

Stamp duty is payable depending on the nature and value of the asset being transferred.

VAT may be payable on the transfer of property. If the pension scheme is registered for VAT, any VAT paid can be recovered by the scheme. But, the cash resources will have to be found to pay the VAT. However, if the property is subject to an existing tenancy, it may be possible to treat the transaction as a “transfer of a going concern” and VAT will not have to be paid and recovered thus easing the cash flow requirements of the scheme.

Professional Advice Is Essential

These notes are not intended to be a definitive guide and there are still some aspects relating to HMRC's interpretation of the legislation and how such transaction can be carried forward in compliance with the regulations that are not entirely clear. It is, therefore, essential any employer, member or trustee considering in-specie contributions obtains specialist advice. Taylor Patterson is well placed to provide that advice to employers, trustees, members and their advisers.