This must be no greater than 50% of the net value of the scheme assets at the date the loan is drawn down. This test is only applied at the date of drawdown – i.e. if the value of the scheme assets subsequently reduce then the borrowing does not need to be re-adjusted.
The maximum loan term is 5 years. All capital and interest must be repaid by the loan maturity date. If, at maturity, the borrower is in ‘genuine financial difficulties’ then the loan can be rolled over for a further 5 years.
A first legal charge must be taken on an asset of at least equal value to the face value of the loan including interest. The charged asset does not necessarily need to be owned by the borrower (although normally it would be) and can be replaced throughout the term of the loan, subject to meeting the minimum value requirements. Where an asset other than unencumbered property such as land or buildings is used for security, the Trustees must be able to demonstrate to HMRC that an arms’ length lender would be prepared to grant a loan in identical circumstances.
Interest must be charged on the loan at a commercial rate. The interest rate is fixed at the outset of the loan, and must be a minimum of 1% above the average base lending rate of six high street banks (Bank of Scotland, Barclays Bank plc, HSBC plc, Lloyds TSB plc, National Westminster plc and The Royal Bank of Scotland plc).
Equal instalments of both capital and interest must be paid for each complete year of the loan. Repayments could therefore be made monthly, quarterly, half yearly or annually – in advance or arrears.
HMRC stipulate that the loan must be ‘for the purposes of the trade, profession or vocation carried on by the sponsoring employer or for the purposes of the sponsoring employer’s administration or management’. Borrowers should, where possible, retain documentary evidence regarding use of the loan proceeds (i.e. to demonstrate capital expenditure etc).
It is essential that the terms of the loan agreement are strictly adhered to by both the Trustees (lender) and the Employer (borrower) throughout the full term of the loan. Non compliance with any aspect of the HMRC regulations could result in hefty tax penalties of up to 70% and could also jeopardise the scheme’s registered status.