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Who schemes can lend to

There are restrictions on who pension schemes can lend money to and, if lending does take place, certain conditions must be met. The rules are much stricter for loans to connected parties.

In addition, pension scheme trustees and product providers may set their own restrictions on whether a scheme can lend and, if so, to whom.

Connected parties
In general, pension schemes are not allowed to make loans to connected individuals or other connected parties - but there's one exception.

Occupational pension schemes can lend money to sponsoring employers, even where connected parties control them. These employer loans are, however, subject to strict rules.

Firstly, an occupational pension scheme can't make an authorised employer loan at all unless:

• the scheme has less than 12 members and
• all members are trustees of the scheme and
• the scheme rules need all members to agree in writing before any employer related investment is made

This effectively means that only a SSAS can make authorised employer loans.

Secondly, there are five key tests which the loan must satisfy to qualify as an authorised employer loan. These cover the maximum loan amount, the term of loan, security, interest rates and repayment terms.

Unconnected third parties
In theory, all pension schemes are able to lend money to unconnected third parties. But, given the potential scope for abuse, many pension trustees and product providers don't actually allow third party loans under their schemes or products.

There's no limit on the amount of such loans and no statutory controls on the length of the loan term or the repayment terms. But HMRC expects all pension scheme loans to be prudent, secure and made on normal commercial terms.

Non-commercial loans can result in unauthorised payment tax charges, as will loans that break the taxable property rules.

Investments in company debt

HMRC don't treat pension scheme investments in publicly available company debt instruments as pension scheme loans. This includes:

• debentures (or debenture stock)
• loan stock
• bonds
• certificates of deposit

This means that investments in these debt instruments aren't restricted by the pension scheme loan rules.

But if the debt instruments are not publicly available (for example, loan notes issued by unlisted companies) the pension scheme loan rules apply.

SSAS employer loans

There are strict conditions for SSAS loans to a sponsoring employer, all of which must be met. If these rules are broken, it may result in unauthorised payment tax charges.

The following rules apply to loans made on or after 6 April 2006:

• Amount - the loan must not be more than 50% of the scheme's net fund value at the loan date. The loan doesn't have to be re-tested at a later date if there's a drop in value of the scheme assets, unless the terms of the loan are changed.
• Security - the loan must be secured throughout the full term as a first charge on a non-depreciating asset of the borrower. This asset must be of at least equal value to the loan (including interest) and if it's replaced by another asset, the replacement must be at least equal in value to the lower of the market value of the asset it has replaced, or the amount of the outstanding loan (including interest).
• Interest - the loan must bear interest of at least 1% above base rate (using the average base lending rate of the six leading high street banks, rounded up to the nearest 0.25%).
• Repayments - the loan must be repaid by equal instalments of capital and interest each year.
• Term - the term of the loan must be no longer than five years from the date the loan was advanced.
  
  But if an employer is in genuine financial difficulties and can't repay an employer loan by the due date, it's possible to roll over the loan by extending the original loan term by up to five years. However, this can only be done once.
  
  The rollover isn't treated as a new loan, so there's no new test against the 50% limit and the existing loan security can continue (even if it's no longer worth as much as the debt). But any increase to the original loan will be treated as a new loan and will therefore be tested against the 50% limit.

Unauthorised payment tax charges can also arise where taxable property is used as security for the loan, or where the loan is used to invest in taxable property.

Pension loans and the taxable property rules

In theory, a borrower can use a loan from a pension scheme for almost any purpose. But the taxable property rules can result in heavy tax penalties where loans from investment-regulated pension schemes (such as SIPP or SSAS) are used to invest in taxable property (residential property or tangible moveable property).

Purpose of loan
Loans made by investment regulated pension schemes will break the rules against indirect investment in taxable property if the borrower uses a loan to invest in taxable property. This is treated as if the scheme had invested directly in the taxable property concerned, with the resultant unauthorised payment tax charges.

Security of loan
If the security used for a loan would be regarded as taxable property, HMRC have confirmed that this can also give rise to an unauthorised payment. When acquiring an interest in taxable property, the unauthorised payment is the sum of:

• the amount of consideration given for the interest and
• the amount of any fees or costs in connection with the acquisition.

In HMRC's view, no consideration would generally be given for the acquisition of a first charge, though there may be fees or costs involved with putting it in place. If so, any sums paid give rise to an unauthorised payment - but this is likely to be quite small.

If the scheme has to enforce the charge, the full value of the property will be used. The acquisition of a further interest in the taxable property caused by enforcing the charge will create an unauthorised payment based on the market value of the property.

Exemption for some occupational pension scheme employer loans
There's an exception to this general rule for some occupational pension scheme employer loans. An authorised occupational pension scheme employer loan from an investment regulated pension scheme to a sponsoring employer which is used to invest in taxable property doesn't break the rules against indirect investment if:

• the property is used for the purposes of the employer's business and
• it's not used by a member or anyone connected with a member.

For example, a loan from a SSAS to the sponsoring employer to buy industrial machinery for use in the employer's business wouldn't fall foul of the taxable property rules, but if the loan was used to buy a company car for use by a SSAS member, it would break the rules.

Penalties for breaking the pension loan rules

If the loan rules are broken, an unauthorised payment is deemed to have been made from the pension scheme and this normally results in unauthorised payment tax charges.

The following are the kinds of things that HMRC regards as unauthorised payments where loans are concerned. HMRC's Pension Tax manual explains the unauthorised payment calculation for the associated rule break:

• The borrower not making loan repayments when due
• An employer not paying a commercial rate of interest on an employer loan
• An employer not providing proper security for an employer loan
• A scheme making an employer loan above the 50% limit
• The term of loan exceeding five years (unless the rollover requirements are met)
• A scheme making a loan to a prohibited connected party - the amount of the loan is an unauthorised payment

Unauthorised payment tax charges can also arise where taxable property is used as security for the loan, or where the loan is used to invest in taxable property.