Before A-Day, unquoted shares did not feature on HMRC’s permitted investments list for Sipps. Following the rule changes introduced on April 6, 2006, unquoted shares have been allowable investments but the rules are not straightforward.
Instead of prohibiting particular investments, the authorities created the concept of taxable property and with it a minefield for SSAS and Sipp providers.
As a general statement of principle, unquoted shares will count as taxable property because the company will almost certainly hold tangible moveable assets which are taxable property. Through any shareholding, the scheme will also end up owning these assets indirectly.
Under the legislation, tax charges will apply to the investment unless one of two exemptions apply. It goes without saying that exemption is essential otherwise the tax consequences for both the member and possibly even the scheme itself are draconian.
The first exemption is if the scheme holds less than 10 per cent of the company shares, including the shares that the member and any connected person might hold.
This is a useful exemption, particularly for bigger private companies, which can also comply with the minimum asset criteria, perhaps where the member currently has no involvement in the company and wants to take a small stake, possibly as a prelude to an eventual float. Generally, although care must be taken, such an investment should not cause to much of a problem.
The liquidity of unquoted shares could also be a problem, particularly when cash is required to provide benefits
The second exemption is much more tricky. This exemption is available for trading concerns in which the scheme, together with the member and connected persons, holds less than 50 per cent of the shares.
In addition, neither the member nor any connected person can be a controlling director, that is, a director owning directly or indirectly 20 per cent or more of the shares.
Here it is likely that the member already has some involvement with the company. Sometimes, it will be clear that the involvement is limited and the total share ownership will come comfortably within the rules and will not be taxable property. Often, it will not be so clear.
If there is any family involvement, for example, it may be difficult to determine whether or not the member, if a director, comes within the wide definition of a controlling director, even when he personally holds less than 20 per cent of the shares but the total family holding is more than this.
Similarly, even where the member is not a director and not even a shareholder, the connected party rules will apply. These are not just confined to family shareholdings or those of associated companies, they also cover a very subjective concept – the business partner.
If the member has any involvement in the company more than as a passive shareholder, it could be argued that potentially he could be classed as a business partner of a much wider range of shareholders and directors than just family.
In addition to the rules determining the tax-exempt status of any investment in unquoted shares, there are several other issues of concern for Sipp or SSAS providers. Valuation of unquoted shares can be very complex, particularly involving minority holdings.
The liquidity of unquoted shares could also be a problem, particularly when cash is required to provide benefits.
Lastly, there is the potential liability that the Sipp trustee has as a shareholder in a company about which it may have little knowledge, yet whose vote on major issues such as a company sale or reconstruction could be crucial and even the subject of legal proceedings.