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Pension scheme share investment

Registered pension schemes can (in theory at least) invest in listed or unlisted shares, either in the UK or overseas. They can hold the shares directly, or invest through pooled vehicles such as unit trusts or insurance products.

However, there are controls that restrict some schemes' share investment options. These controls are intended to encourage sensible investment behaviour and reduce the scope for abuse of the tax breaks available.

The controls are generally built around the principle that abuse is most likely to take place where shares in companies connected with the pension scheme, or its members, are involved. So they focus on areas where certain kinds of pension scheme might otherwise have scope, and the temptation, to bend the rules.

As a result, pension scheme investments in the shares of connected companies are subject to strict rules. There are different rules for investments by:

• Investment-regulated pension schemes (such as SIPP and SSAS) and
• Occupational pension schemes investing in employer-related shares

In addition, pension scheme trustees and product providers may limit the investment options available under some pension schemes or products.

Historically, over the longer-term, shares have given higher investment returns than other traditional kinds of investment. That's why pension schemes have, over the years, found share investment attractive - for instance if trustees want investment returns to keep pace with the pension scheme members' salary growth.

On the downside, share investments have tended to be more volatile than many other kinds of investment - meaning that the value can change a lot in a very short period. This risk means that pension schemes have to be careful that any share investments they make are consistent with the scheme's aims - particularly the need to pay benefits when they're due.

Having said that, the development of increasingly flexible pension vehicles like SIPPs, offering income drawdown and phased retirement as well as wide investment choice, have made this volatility risk easier to manage in many cases.

Pension investments in connected shares

HMRC's taxable property rules place controls over share investment by investment-regulated pension schemes (such as SIPP and SSAS), by treating most investments by them in the shares of a connected company as investments in taxable property subject to unauthorised payment tax charges.

SSAS investments in employer-related shares are also subject to separate controls under DWP rules.

An investment-regulated pension scheme will be treated as having invested in taxable property if it buys shares in a trading company:

• that's controlled by the investment-regulated pension scheme and/or associated or connected parties or
• which scheme members or connected parties are controlling directors of or
• which a company, that scheme members or connected parties are controlling directors of, holds an interest in (either directly or indirectly)

and

• which holds any individual item of tangible moveable property (unless valued at no more than £6,000 and held solely for the purposes of administration or management of the business) 

Tangible moveable property means any asset that can be touched and moved. As this includes assets such as machinery and vehicles, this rule effectively means that most SIPP or SSAS investments in the shares of a connected company will fall foul of the taxable property rules.

These rules apply regardless of whether the shares are listed or unlisted. However, the main adverse impact is likely to be on potential SIPP or SSAS investments in unlisted shares, many of which might be completely scuppered by the taxable property rules.

The rules won't generally affect SIPP or SSAS investments in shares listed on the principal exchanges, but they might well rule out potential investments in smaller companies such as those listed on AIM.

Shares held before 6 April 2006

In some circumstances, the rules in place before 6 April 2006 allowed some kinds of pension scheme to hold investments in connected company shares that would now be regarded as taxable property.

As long as these investments were allowed by HMRC at the time the shares were bought, they can be kept without breaking the taxable property rules.

Connected shares – investment limits

The amount of a pension scheme's funds that can be invested in shares in a connected company depends on:

• the structure of the pension scheme and
• whether it is an occupational pension scheme or a personal pension scheme

Occupational pension schemes (including SSAS)

Aside from the taxable property rules, there are two different sets of DWP rules that specifically control investments by occupational pension schemes in shares of the sponsoring employer or associated companies (known as employer-related shares).

• Firstly, occupational pension schemes can't invest more than 5% of their assets in employer-related shares unless:
  
  • the scheme has less than 12 members
  • 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
  In practice, this effectively means that the only occupational pension schemes able to meet the above rules and make significant employer-related share investments are SSAS.
• Secondly, occupational pension schemes (even SSAS) can only invest a maximum of 5% of the fund in the shares of any single sponsoring employer. Also, in total, occupational pension scheme investments in employer-related shares can't be more than 20% of the fund value. For example, a SSAS could invest 5% of the fund in shares four sponsoring employers.
  
  There's no statutory limit on the size of the shareholding - only the percentage of the pension fund an occupational pension scheme can invest in employer-related shares is limited. So, in theory, an occupational pension scheme could wholly own its sponsoring employer if 5% of the pension fund was big enough to buy the entire share issue of the company. However, this could result in the pension scheme being reclassified as a trading vehicle, with the knock-on tax implications.

• Finally, even where the above hurdles are cleared, the taxable property rules for investment-regulated pension schemes might still rule out some potential SSAS share investments.

Personal pension schemes (SIPP)

Neither DWP nor HMRC regard personal pension schemes as employer-sponsored arrangements, so the 5% and 20% limits that apply to occupational schemes do not apply to personal pension schemes. Personal pension schemes can, in theory at least, invest 100% of their assets in shares of the member's employer - but, again, the taxable property rules might rule this out.

Taxation of pension share investments

Any individual, or company, selling shares to a pension scheme is subject to tax on any gain in the usual way.

The pension scheme has to pay stamp duty of 0.5% of the share value (rounded-up to the next £5) on any shares it buys, unless the share value is under £1,000.

However, once a pension scheme owns shares, they're held in a very tax-advantaged environment. In particular:

• dividends are free from income tax and
• capital gains are free from capital gains tax