COULD your Tuscan holiday villa form part of your pension fund, and could you buy an apartment on the Spanish coast with a little help from the British Government? This is the hope held out by proposed changes to pension legislation due to take effect next year. From “A-Day”, April 6, 2006, self-invested personal pension (Sipp) funds will be allowed to invest in residential, as well as commercial, property, and that includes property abroad.

Property companies say that the new rules could create a new class of jet-to-let investor, but Sipp providers are sceptical, arguing that investing in foreign property through a Sipp will be complicated and that the British tax benefits could be offset by the need to pay tax overseas.

Sipps are a flexible type of pension fund. They used to be marketed at the wealthy, but in recent years they have become cheaper to run and more popular. Allowing people to hold residential property within Sipps is likely to boost their popularity.

On the face of it, the benefits of buying your holiday home within a Sipp are significant. Contributions to a pension fund attract full tax relief up to the maximum annual allowance of £215,000, so if a higher-rate taxpayer were to buy a Spanish villa for £200,000 it would cost just £120,000, with the Government making up the rest. Rental income is free of tax, as are capital gains. Income goes directly to the Sipp, where it can be reinvested or used to pay off the mortgage. Borrowing is allowed, up to a maximum of 50 per cent of the value of the pension fund. In other words, if you have £100,000 in your Sipp, you could buy a property worth £150,000.

If this all sounds too good to be true, then that is because it is, Sipp administrators say. They point out that there are many problems in buying property abroad through a pension fund. One is that Sipps are set up as discretionary trusts, a legal structure that few European countries recognise. So, for example, to buy a property in Spain you would need to set up a Spanish company to buy the property, with the Sipp owning shares in the company. This could be costly and time-consuming.

Moreover, they argue that tax savings in Britain could be offset by the need to pay tax abroad. Because pension funds are not taxable at home, double taxation treaties do not apply. So, in the Spanish example, if the property were owned through a company, corporation tax at 40 per cent would be payable on rental profit, while capital gains tax of 15 per cent would also be due. If the property were owned directly, the tax burden could be even higher.

Anyone wishing to buy a holiday home through their pension fund should also be aware that, whenever they want to use it, they will need to pay market rent to their Sipp in order to avoid falling foul of HM Revenue and Customs rules. However, for investors keen to get started there are ways of getting into the market now. Stuart Law, of Assetz, a property investment company, says: “Some pension administrators are already buying property on behalf of clients within Sipps. This is possible before A-Day, so long as the property does not yet have a certificate of habitation and so is not deemed residential.”

Assetz: www.assetz.co.uk, 0161-456 4000

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