Charles Batchelor, Financial Times

Holiday home owners, estate agents and property advisers in popular tourist destinations in Europe and beyond are rubbing their hands at the prospect of changes in the rules governing UK self-invested personal pension plans (Sipps).

When the regulations change next April, investors in Sipps – pensions that give investors far greater control over their investments – will be able to put residential property, including property owned overseas, into their pension plan. The popularity of foreign holiday home ownership – fuelled in part by television lifestyle programmes and low-cost airlines – suggests that a lot of property could be switched into Sipps.

Sipps provide full income tax relief at the owner’s marginal rate on the purchase price so a top-rate taxpayer could buy a £100,000 flat for just £60,000. In addition, rental income from the property rolls up tax-free in the Sipp. The Sipp can also borrow up to 50 per cent of the worth of its funds.

But Sipp providers and pension advisers are quick to point out several potential pitfalls and that “wrapping” your holiday home in a Sipp may not be as easy – or as lucrative – as it appears.

Legal & General, the insurance group, does not plan to allow foreign properties to be included in its Sipp portfolios because of problems that can arise over establishing ownership rights. Even in the UK, it will restrict residential property to buy-to-let properties and exclude holiday homes.

“We take a cautious approach to investments,” says Adrian Boulding, pension strategy director at L&G. “[This scheme] is for people who want to use their pensions for genuine investment purposes.”

The first problem facing investors who want to use their Sipps to hold overseas properties is the lack of UK-style trust legislation in many countries – notably the popular tourist destinations of Spain and France. This would mean the Sipp ownership structure would not be recognised.

“A Sipp established as a trust cannot legally own property in Spain,” says Andy Bell, managing director of AJ Bell, a Sipp provider. “So you would need an alternative structure which could involve your pension fund setting up a company to own the property or some form of nominee arrangement. But this would not be straightforward and any structure involving an overseas company is likely to increase costs.”

Other countries that do have trust structures may lack other professional services that would be needed to arrange these transactions. Egypt is keen to boost “residential tourism” and its legal system accepts trusts but more work needs to be done in areas such as title deeds and residential visas, says Ian Marsh, development director of Thinc Group, a distributor of financial services.

Newcomers to owning property overseas must also take into account the complexity of local planning laws. Buyers in some parts of Spain found new development plans could override their ownership rights. “The principle of caveat emptor applies in spades,” says Stewart Ritchie, pensions director at Scottish Equitable.

They must also be aware of the higher cost of acquiring property abroad. “It is expensive if you have to hire a lawyer, a tax adviser, a surveyor and a property manager over there,” says Ian Dawson, sales and marketing director at Wolanski, which acts as a trustee and administrator of Sipps.

Carrying out alterations to a property that is in a Sipp may also cause problems. The Sipp trustee, rather than the owner, has the final say and will probably insist that a registered tradesman does the work, not the retired builder who lives in the next villa. This could cause delays and add to costs.

While a Sipp provides a tax shelter for the UK assets held in it, taxes in other countries will not be covered. Rental income on property in Spain incurs tax at 25 per cent with no offset for interest or expenses. Capital gains tax would be charged at 35 per cent while transfer taxes and notary’s fees incurred when buying a property could add up to 10 per cent of its value.

And the UK taxman will take a close interest in the extent to which the owner uses the property compared the length of time it is rented out.

If the owner uses the property he will be required to pay rent to the Sipp. Even if the owner mothballs the property for 46 weeks of the year because he does not want to rent it to strangers he may be regarded as using it and it could be taxed as a benefit in kind for this unused period.

“What the Inland Revenue will not do is send an inspector to Tuscany to verify that you are not occupying the villa,” says Ritchie. “It will assume you are getting the benefit from the full 52 weeks of the year. The way around it is to demonstrate that you have put it in the hands of a commercial letting agent for 46 weeks.”

Some Sipp experts believe the tax charges will be so steep that owners will prefer to pay rent for the full year so that at least the Sipp has the – tax exempt – benefit.

“Anyone who is aware of these issues is going to think twice about putting property into a Sipp,” says Tom McPhail, head of pensions research at Hargreaves Lansdown, a firm of financial advisers. “The numbers doing it will be in the tens of thousands rather than the hundreds of thousands. The more I look at it the more negative I become.”