As investors look to more esoteric investments in a bid to deliver strong growth, Mary Stewart looks at the need for true due diligence
One of the consequences of the economic turbulence has been growth in interest in non-standard investing. We regularly receive enquiries from IFAs whose clients are keen to make use of the self-directed element of their SIPPs by switching funds into gold bullion, hotel rooms, unlisted shares or to loans to third parties.
SIPPs have encouraged a growing awareness of the whole universe of investment potential that exists beyond the mainstream investments of funds, shares and gilts. Turmoil in the financial markets has arguably accelerated this, perhaps because it has made investors question the ability of standard investments to protect them during hard times and deliver strong growth during the good times.
Instead people are looking for a more novel approach, sometimes for a significant chunk of their funds. One of the fastest growing areas of interest is in ecological/ethical investment, a theme that holds out the positive possibility of significant returns without the negative impact on the environment or other people.
Investing on an ethical or an environmental basis is not new and there a growing number of collectives that seek to take advantage of indirect holdings. We are also seeing the launch of many more direct investment opportunities, based on projects in places such as Africa, South America and Asia. These are higher risk, higher potential return investments that are likely to be well diversified from many of the other assets within the clients’ portfolios.
The investment flexibility of SIPPs or SSASs allows pension savers to access these kind of investments while still enjoying the long-term tax efficiency of investing within a pension wrapper. In many cases such investments will be the cherry on top of an otherwise standard portfolio, adding interest, excitement and what is probably viewed as limited downside with good growth potential.
Accessing these emerging opportunities is dependent on the pension provider, IFA and client working as a team. While the adviser can alert clients to their existence and decide whether they are suitable, it is the role of the pension provider to carry out its own due diligence to confirm that they are eligible for inclusion in a SIPP and do not trigger tax penalties from HM Revenue & Customs.
The structure of the investment is all important. We have recently seen an investment in South America based on the planting of trees whose seeds yield oil that can be used as an eco-friendly biofuel. In this case it was the sale of the oil that produces the return, but in others the goal is reforestation of rainforest with the sale of carbon credits producing the returns.
In either of the two cases above, if the SIPP or SSAS was seen as selling the oil or the carbon credits it would be viewed by HMRC as trading. This means the pension would need to pay tax on the resultant income, diluting the attraction for pension investors. In another example, if the pension had ownership of the seeds or the timber in a forestry-based investment, that would be seen as ‘tangible, moveable property and be hit by the taxable property rules.
Structuring the paperwork correctly can avoid the pitfalls and maximise the tax-efficiency of these kind of investments to UK pension investors. For example, the pension could own the land, leasing it to a third party which owns the seeds or timber and is responsible for the sale of the product. Rent is paid to the pension from the profits generated. The pension is therefore not holding taxable property, and rather than receiving a trading return, it gets a rental.
Advisers have a responsibility to ensure they carry out due diligence on these kind of funds before recommending them to their clients. The pension provider can provide significant support to the adviser by scrutinising the underlying structure to identify any problems it may cause with HMRC. This does not depend on whether an investment is regulated or unregulated – commercial property, a SIPP portfolio ‘staple’, is not regulated. The difference is that most clients do have a reasonable understanding of how the commercial property market functions, but may not be so well versed in tree oil, which is why there is more onus on the professionals to investigate.
We are happy for clients to place these kind of investments in the schemes we offer on the proviso that after examination we are satisfied they are acceptable for inclusion in a SIPP or SSAS. But ultimately the buck stops with the adviser who still needs to be satisfied the investment is suitable for the client.
A recent survey suggested about a third of IFAs wanted all SIPPS to have the capability to allow clients to hold unlisted shares with reasonable numbers also wanting scope to invest in overseas commercial property, third party loans or derivatives. Clearly there is an appetite among advisers to offer innovative new investments and asset classes.
Mary Stewart is a director at Hornbuckle Mitchell
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