Business borrowing: What’s a loanback got to do with it, got to do with it

We have changed the way we live, the way we think, the way we eat, the way we interact, and perhaps more noticeably, the way we work.

Pre-COVID-19 there were many ways that businesses could raise finance, none of which would have included the Coronavirus Business Interruption Lending Scheme (CBILS) and the Bounce Back Loan Scheme (BBLS). One of the most important factors to any business is cash flow and owner-managed businesses may have had to seek alternative methods to secure funds.

The traditional way

In the not too distant past, a limited company would look to a bank or third-party arrangement for a business loan. Rewind to an even earlier time when the individual may have physically gone into the bank, shaken the bank manager’s hand and discussed loan terms face to face… which now all sounds like an outlandish concept!

Invariably the traditional method for businesses looking to the bank for a loan is not as forthcoming as it once was, and this has only been exacerbated by the pandemic. For borrowers, the good news is that interest rates are at a historic low; the not so good news is that banks and lenders are reluctant to provide the finance… which creates a sort of ‘this is what you could have had’ scenario!

An alternative strategy

There are circumstances where businesses have short term cashflow needs, they have a good opportunity in terms of on-going orders and businesses in the pipeline and those businesses are contemplating going to the bank for funds or not being able to meet future contracts. As mentioned above, the traditional way is either not working or is too costly. With many people currently sitting on cash via their pension scheme a loan to your own company could be an investment decision that some look to undertake.

Rather than going to the bank they are utilising their pension fund to loan money back to their business on more-or-less the same terms that the bank would’ve done. Which includes, but is not limited to, a fixed rate of interest and security, I will expand on both below.

Ultimately what this does is provide an investment strategy for the pension fund where it is invested via a loan in return for an interest rate but at the same token provides cashflow for the business. Many people will feel more comfortable paying a return to the pension fund rather than a high street bank.

This can only be done via a Small Self-Administered Scheme (SSAS).

Five golden rules

There are five key tests that a loan must satisfy to qualify as an authorised loanback from a pension scheme per HMRC’s guidelines. If a loan fails to meet one or more of these tests, there could be an unauthorised payment charge leading to potential punitive tax charges. These are as follows:

• Security – The loan must be secured over the full term of the loan on a first charge basis on an asset with a value at least equal to the value of the loan plus interest.
• Interest rates – The SSAS must charge interest on the loan at a rate of at least 1 per cent above the lending rates of six leading high street banks. The rate of interest being applied should be on a commercial basis.
• Term of loan – The loan term should be written at no more than five years, but this can be rolled over once.
• Maximum amount of loan – The loan must not be more than 50 per cent of the net asset value of the pension scheme. This is calculated at the point immediately before the loan is made.
• Repayment terms – The loan must be repaid in at least equal instalments of capital and interest and it must also be payable at least annually.

The wins

The pension fund receives interest on the loan and, in turn, will grow in value as a result. For example, if the interest terms are agreed at 5 per cent per annum (this must be determined on a commercial basis), then the pension fund will be receiving a return that is difficult to obtain in today’s volatile markets and also outperforms the 0.01 per cent if the funds were sat in a cash account.

It is worth mentioning that the loan interest is potentially a tax-deductible expense for the limited company.

The business receives the loan and not having to go to the bank to achieve this, can be described for many as a win in itself!

I don’t think it would be bold to say almost everyone enjoys control over their own finances and entrepreneurs and business owners probably top the list, many will enjoy the comfort of control knowing that they are the director of the limited company and also the trustee of the SSAS. Although the limited company and the pension are two separate entities, the common denominator is the director(s), which can be a compelling reason for many to explore loanbacks.

In addition to the loanback facility, the SSAS can purchase commercial property, company shares, intellectual property, and invest into market portfolios. All of which creates the opportunity to build up a valuable retirement fund for the director’s future needs while also creating a legacy for future generations. The list of its capabilities is more extensive, but perhaps the explanations of these are better left for another day!

It’s not all sunshine and rainbows

Loanbacks are not the solution for everyone. The suitability of a SSAS should be carefully considered by the individual(s) and the respective advisory parties rather than seeing this as a cash flow exercise. The loanback should be first and foremost a good investment strategy whilst having the added benefit of providing cashflow for the business, and although being the director of the limited company as well as a trustee of the SSAS seems attractive, it’s important that these transactions are looked at as two separate entities to avoid potential conflicts of interest. 

The trustees of the scheme will need to be careful because, ultimately, if they are risking pension money that is earmarked for retirement, consideration needs to be given to whether or not the loanback is a good investment for the pension scheme to make.

The scheme would need to employ a solicitor to register the legal charge against the loan, which is of course an additional cost that needs to be considered by the SSAS members.

Loanbacks via SSASs have been around for many years but if not administered/advised correctly, SSASs can be inefficient for loanbacks and for that reason they can be misunderstood.

Team effort

When used correctly the above planning can be very powerful. A SSAS is an occupational pension scheme fully approved by HMRC and it is aimed specifically at meeting the needs of directors of limited companies.

We are not living in ordinary times and therefore the traditional way of doing things may not be the best solution. So we must ask the question, is a loanback that ‘out of the box’ alternative that could help your clients?

As the title was inspired by the great Tina Turner, it is only fitting that we sign off in the same way … the main priority for us all is finding ‘simply the best’ outcomes for our clients.

Anthony Rowe, Wealth Management Consultant at Mattioli Woods plc