Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Use AIM stocks to avoid 40% inheritance tax
If you want to invest in companies with significant growth potential and cut your estate’s inheritance tax (IHT) bill on your death, investing in AIM-listed stocks could be the answer.
Certain AIM companies benefit from business property relief (BPR), which makes the shares exempt from IHT as long as you hold them for at least two years and at death.
AIM-quoted stocks are eligible for inclusion in ISAs, meaning you can also shelter them from income tax and capital gains tax.
It’s possible to benefit from BPR by buying AIM shares through your stockbroker/investment platform. The executor of your estate will claim the tax exemption when you die, so as long as you’ve met the two-year holding rule and the companies qualify for BPR, your descendants will be spared a 40% IHT bill on your ISA.
Picking qualifying companies
Trying to identify which stocks will qualify for BPR is when problems can arise. Unfortunately there isn’t a definitive list because the qualification status of a company can change over time.
For example, BPR will no longer be available if the company is sold or wound up, unless either event results in the business carrying on.
BPR is not available for companies that mainly deal with land or buildings. This isn’t always easy to determine and it can be quite subjective.
To ensure you give your descendants the best chances of benefitting from BPR, it’s worth looking at the stocks that specialist AIM portfolio managers invest in. There are several organisations which run ISA portfolios that are specifically designed to be IHT-exempt.
The Octopus AIM Inheritance Tax ISA invests in around 30 stocks including pub company Young & Co’s Brewery (YNGA:AIM), café and cake shop Patisserie (CAKE:AIM), pharmaceutical company Clinigen (CLIN:AIM), document storage company Restore (RST:AIM) and engineering services provider Renew (RNWH:AIM).
Using a portfolio manager
Although these companies currently qualify for BPR, there is no guarantee they will do in the future.
Alex Davies, chief executive of Wealth Club, claims this uncertainty means a lot of investors shun the DIY investment route and go via a manager instead. These providers tend to use third party accountants to verify qualification.
We believe it is possible to pick the investments yourself and not have to resort to the services of a wealth manager, unless you are short of time and/or prefer someone else to do the hard work.
One obvious way is to contact an AIM company directly as they may well know if they qualify. Some companies even publish this information on their website. Investor’s Champion has an online search tool to identify qualifying AIM companies, although there is a fee for this service.
Screening for stocks
Chris Hutchinson, manager of the Unicorn AIM IHT Service, says his team has a stringent set of investment criteria in order to screen the index.
The team typically looks for three characteristics: the company must produce consistent earnings and dividend growth, without masses of debt; it must sell a product or service that delivers a tangible benefit to its customers; and, ideally, the founder and/or management team should retain a meaningful equity stake in the business.
‘It’s not so much about picking the winners, but avoiding the howlers and this approach has been effectively employed by the team for almost two decades now,’ says Hutchinson.
The downside of using a manager is it will be a lot more expensive than investing via your platform. If you invest directly with Octopus (i.e. not through a financial adviser) you’ll have to pay an initial charge of 1% as well as an annual management charge of 2% plus VAT.
Richard Power, head of quoted smaller companies at Octopus Investments, claims these fees are justified because there is a team of eight people running the portfolio who conduct site visits to each company and check the stocks still qualify for BPR. Investors also get updates sent to them so they can follow their investments.
Since its launch in 2005, the Octopus AIM Inheritance Tax Service, which is managed in the same way as the ISA, has grown by 186% in value. This compares with a 7% decline in the FTSE AIM All-Share and 119% rise in the FTSE All-Share.
Beware the risks
Whichever route you go down, it’s important to realise that investing in AIM stocks is risky. Most of the businesses are younger and smaller than Main Market listed companies and the share prices can swing significantly. Having said that, the average market cap of the stocks in the Octopus portfolio is £470 million, which is by no means tiny.
Power reckons AIM portfolios are only suitable for people who understand the risks of investing in small companies.
‘It is possible to do IHT planning in other, less risky ways although you wouldn’t be exposed to as much growth potential. Academic studies show that over five to six years, small caps will outperform large caps,’ he says.
Most experts advise looking at the investment merits of stocks first and then viewing the tax benefits as an added bonus.
If you would like more information, click here to read a longer article we published last year on AIM/IHT.