The rules around inheritance tax (IHT) in the UK are notoriously complex leading to regular calls for the system to be simplified. Changes in 2017 led to the new residence nil rate band threshold, which means that by tax year 2020/21 a couple could pass an additional £350,000, of the value of their family home, to direct family members free from inheritance tax. However, regardless of this new threshold, inheritance tax revenues continue to rise, with 2017/18 seeing the value of tax collected exceeding £5 bn for the first time in the UK. Without putting in place necessary tax planning arrangements, families risk not passing on a large portion of their assets to relatives or family members.
Often described as the “voluntary tax”, there are many appropriate planning options available to allow families to escape inheritance tax and see more of their wealth transfer from one descendent to the next. One option for mitigating inheritance tax is to invest in shares listed on the Alternative Investment Market (AIM).
AIM is a sub-market of the London Stock Exchange that was launched in 1995. It was established to directly benefit smaller companies by helping them to raise capital to enable their growth and expansion. It contains companies from a wide range of sectors and at various stages of their development, including start-ups, venture capital backed organisations and companies that are long established.
The key point about AIM and IHT planning is that many AIM stocks benefit from business relief, providing the investor holds them for a minimum of two years and at the time of death. Stocks must be held directly in a client’s name rather than as investments in a fund. An investor doesn’t always need to hold the same AIM shares, as switching between shares that qualify for business relief, doesn’t restart the necessary two year holding period. In addition, in the unfortunate event of the investor dying before the two year minimum period is met, a surviving spouse or civil partner can inherit the portfolio without restarting the required holding period.
Investors can also shelter their AIM portfolio of stocks in an ISA wrapper, which means that their investments will be free from Capital Gains Tax and Income Tax on any dividends. Investors can sell out of their stocks at any time but in order to benefit from any inheritance tax planning, it’s advisable to swiftly re-invest the money, as an investor needs to pass away holding the shares. No-one is immortal and who knows when the day that we breathe our last breath arrives.
Investing in AIM is a popular option for those who are approaching retirement, or are elderly, and have left their inheritance tax planning to the last minute. Unlike property and many other assets, which need to be gifted to beneficiaries some seven years minimum, before the donor’s death, to be eligible for full inheritance tax exemption, investing in AIM stocks is a relatively fast way to reduce a potential inheritance tax liability. AIM portfolios are also straightforward and do not involve some of the legal complexities of trusts.
Sheltering your estate in AIM isn’t without its risks though. AIM companies are not as large or potentially as financially stable as some FTSE 100 or FTSE 250 stocks and so they may be seen as more vulnerable to market pressures. AIM has historically been described as a market full of high risk, under-resourced companies which have been caught out in market downturns, such as during the dotcom bubble. However, over the past decade AIM has ‘grown up’ with the number of stocks listed falling dramatically, while the market capitalisation of the index has grown to over £100 billion. The average AIM company is now capitalised at more than £100 million. One example of a well-known successful AIM company is Fever-Tree, which currently has a market capitalisation of £3 billion.
Although investors can create their own DIY AIM portfolio, I would suggest that anyone considering an investment in AIM as part of their inheritance tax planning should seek the help of an AIM Investment Manager. These discretionary wealth managers will know this index and its companies well. Investing in AIM is a minefield and they are well-positioned to screen potential companies; which will involve looking at balance sheets, profitability, cash generation and meeting AIM company management teams to fully understand the opportunities and risks that these businesses present. An expert adviser will then create a diversified portfolio of AIM shares for the investor.
AIM and IHT – investing in AIM for inheritance tax planning purposes – for everyone. Stocks listed on AIM are often more vulnerable to stock market lurches up and down. However, if an investor looks carefully there are some very well run businesses that have the potential to generate some excellent returns, in addition to providing a much needed shelter from the tax man.
James Rae is portfolio manager at Charles Stanley