Individuals looking to shield wealth from inheritance tax should consider London’s AIM stock market as investing in certain shares can help keep the taxman at bay. The standard rate of inheritance tax is 40% which is a meaningful amount.

AIM shares that qualify for business property relief and held for at least two years do not form part of the estate for inheritance tax purposes and can be passed on after death tax-free. There are some other conditions to meet which we discuss these later in this article.

In 2013 the Government allowed AIM shares to be held within ISA accounts, which means qualifying business property relief shares can be held within a tax- efficient wrapper.

That’s the good news, the bad news is that neither HMRC nor the London Stock Exchange publish a list of qualifying stocks.

This leaves investors with the choice of doing the leg work themselves, taking on the risk that HMRC challenges their decisions, or alternatively using an AIM IHT portfolio provider and paying them a fee to make the investment decisions and to check the underlying stocks qualify for the relief.

WHAT IS BUSINESS PROPERTY RELIEF?
First introduced in the 1976 Finance Act, business property relief was originally meant to ensure that after the death of the owner, a family-owned business could survive as a trading entity without having to be sold or broken up to pay an inheritance tax liability.Over time, successive governments recognised the value of encouraging people to invest in trading businesses regardless of whether they run the business themselves.

The latter route would involve the use of a portfolio service rather than buying an off-the-shelf AIM IHT fund via an investment platform provider because they don’t exist.

Readers who want to pick the stocks themselves could look at the holdings that feature in AIM portfolio services, as providers may publish some positions on their website. We also discuss various stocks that currently fit the bill later in this article.

It’s worth emphasising that it’s not just about working out which stocks might qualify for inheritance tax relief, but also making sure they are good long-term investments. Holdings also need to be constantly monitored to make sure they remain eligible for the relief.

In general, it is worth getting tax advice from a qualified professional when dealing with complicated financial matters.

WHAT ARE THE RULES?

– A qualifying investment needs to be held for at least two years.

– The clock starts ticking from the time you make an investment in qualifying shares.

– Subsequent investments start a new clock ticking so accurate records must be kept on different durations.

– If you sell after two years, you have three years to reinvest the cash.

– You must be invested at the point of death.

It is worth speaking to a tax expert to get full clarification of the rules.

One of the advantages of paying a fund manager to pick the stocks via a portfolio service is that they tend to speak with companies relatively frequently enabling them to stay on top of the latest developments.

For example, when AIM-traded life science tools supplier Abcam (ABC:AIM) was considering dual listing shares on the US Nasdaq exchange, the company canvassed opinions from institutional investors.

Richard Power, who heads up the AIM portfolios at Octopus Investments, told Shares that once he became aware of the dual listing, Abcam shares held across his inheritance tax portfolios were sold because the company would no longer qualify.

The Government treats shares only dealt on AIM as being ‘unquoted’ for the purposes of business property relief. Once they are also listed on a recognised stock exchange as defined by HMRC, such as Nasdaq, they are no longer ‘unquoted’ and will not qualify for business property relief.

WHY AREN’T THERE AIM INHERITANCE FUNDS?

It is not possible under the rules to manage funds that invest solely in companies qualifying for business property relief. That explains why the alternative route for DIY investors is to use portfolio services where each client’s portfolio must be constructed individually, adding costs.

For example, Octopus Investments is one of the largest and established players investing in AIM stocks and caters to over 14,000 clients, offering each their own bespoke portfolio.

All the firm’s portfolios are assessed quarterly for compliance with HMRC rules by consultant PwC, adding further costs. Octopus charges 1.5% annual management fee plus a 1% dealing fee.

That may seem high compared with funds and investment trusts, but clients receive a higher level of service, bespoke portfolios, risk management and peace of mind that portfolios can be passed on free of inheritance tax.

The median Octopus AIM inheritance tax service portfolio has delivered a total return of 227.8% over the last 10 years compared with 38.8% return for the FTSE AIM total return index, according to Lipper and Octopus data.

This highlights that fees should always be assessed alongside the returns achieved, especially in the more complex field of AIM inheritance tax investing.

EXAMPLES OF STOCKS THAT SHOULD QUALIFY FOR THE AIM INHERITANCE TAX STRATEGY

– Wound care company Advanced Medical Solutions (AMS:AIM) should see higher earnings as elective procedures restart post-pandemic.

– Software provider to the hospital sector, Craneware (CRW:AIM) has strong revenue visibility as it migrates existing and new clients to its cloud-based offering.

– Software as a service digital marketing platform provider DotDigital (DOTD:AIM) has clear growth opportunities as it expands overseas.

INVESTMENT CASE STILL IMPORTANT

The mangers interviewed by Shares were keen to emphasise that investment merit remained an important consideration for constructing these AIM portfolios.

Ian Wooley, head of AIM services at boutique fund manager Hawksmoor Fund Managers, said it was imperative that each investment narrative stood up on its own for inclusion in its portfolios.

Wooley looks to invest in high quality companies with strong balance sheets and clear growth drivers. Unlike Octopus the company conducts all its own due diligence in-house on the eligibility of AIM stocks.

Hawksmoor doesn’t have the same liquidity constraints as some of the larger players which means it can fish in the smaller end of the market. It reckons the sweet spot is between £100 million and £250 million market cap.

Wooley believes these companies are less researched, and therefore there is a greater chance of finding under-priced growth.

The larger fund managers are often restricted to the £1 billion plus end of the market, resulting in those firms trading at a premium to the smaller firms.

Richard Power says Octopus has been following the same fundamentally based investment approach for the past 16 years, looking for established, profitable businesses which have reliable, recurring revenues and have attained global leadership.

The companies should have clear growth opportunities and the potential to deliver sustainable double-digit earnings growth over the next few years.

Language translation company RWS (RWS:AIM) has been an Octopus portfolio holding since 2005. An all-share merger with SDL was announced last August and provides a step change for the combined businesses.

Another long-term Octopus position is engineering company Renew Holdings (RNWH:AIM) which specialises in non-discretionary infrastructure maintenance projects.

Hawksmoor’s portfolios include SDI Group (SDI:AM) which manufactures niche scientific equipment, and media group Next Fifteen Communications (NFC:AIM).

While most of the advertising world has struggled during Covid-19, Next Fifteen is a specialist to technology sectors, where there hasn’t been such a sprint to cut discretionary spending. Its client list includes Google, Facebook, Amazon, IBM, Deliveroo and American Express.

Growth in the company’s digital services has been boosted further by lockdowns as more people use the online channel.

THE QUALIFICATION RULES

According to the HMRC website full relief from inheritance tax is available on:

– A business or interest in a business.

– Shares in an unlisted company

WHAT DOESN’T QUALIFY?

– A company that mainly deals in securities, stocks or shares, land or buildings, or in making or holding investments.

– A not for profit organisation.

– A company that is being sold unless the sale is to a company that will carry on the business and the estate is mainly paid in shares of that company.

– A company that is being wound-up, unless it is part of a process to allow the business of the company to carry on.

DIY APPROACH

There is merit in using third parties to manage AIM inheritance tax portfolios, but how might investors go about doing it themselves?

It is possible to manage your own affairs, with the caveat that each individual investor is responsible for keeping adequate records and staying on top of the source of earnings to ensure stock selections remain compliant with HMRC rules.

One source of information to see if a specific stock qualifies for inheritance tax relief is Investor’s Champion. It conducts extensive due diligence into the qualifying status of all AIM companies, and its search tool clarifies the qualifying status of all AIM companies for a small fee per company search.

The company doesn’t guarantee that its selections comply with HMRC rules, merely that they are based on its interpretation of the rules. This isn’t unusual and in line with most AIM portfolio services in the space.

According to Investor’s Champion, 628 companies (76% of the total) qualified for the valuable inheritance tax relief at the end of March 2021.

There was significant ambiguity surrounding the qualification of a further 85 companies where activities may qualify but the relief might be restricted.

GREY AREAS

Chris Boxall from Investor’s Champion and founder of Fundamental Asset Management highlights some of the grey areas to spot when trying to assess whether a company qualifies for inheritance tax relief.

At first sight you might be forgiven for thinking that companies involved in securities trading would breach the rules and not qualify for the relief but Boxall believes that stockbroking company Jarvis Securities (JIM:AIM) does qualify.

The reason, explains Boxall, is that Jarvis undertakes administrative and processing services and does not deal as principal for its own account.

It also receives a substantial part of its total income from interest as well as fees and commissions. The balance sheet does not show it as having any investments and it derives no income from investing activity.

Another potential banana skin is so-called ‘excepted assets’ which are those assets not being used mainly for business purposes or are not required for future use in the business.

Specialist asset manager Gresham House (GHE:AIM) announced in December 2017 that it had received positive indications that it qualified for inheritance tax relief.

But Investor’s Champion still has concerns on the passive investments retained by the company which could be considered excepted assets and restrict the available relief.

SIPP administrator Curtis Banks (CBP:AIM) revealed it had investment property of £1.2 billion and investments of £2 billion at 31 December 2020, suggesting it would likely be considered an investment company and therefore not qualify for inheritance tax relief.

However, Investor’s Champion believes that because the items relate to one of Curtis Banks’ insurance subsidiaries and the company bears no insurance risk, it does qualify.

OTHER WAYS OF SHIELDING ASSETS FROM THE TAXMAN

Make sure you utilise your ISA allowances which can be passed on to your spouse after death tax-free. Your spouse will benefit from an additional one-off allowance equal to the amount in your ISA at death. Adult investors can deposit up to £20,000 across all types of ISAs each year, apart from the Lifetime ISA which is capped at £4,000. Someone investing £4,000 in an Lifetime ISA would still be free to invest a further £16,000 across other types of ISAs in a tax year.

Reducing your estate by gifting can lower your tax bill. More information can be found in this article.

According to Jessica Franks, head of tax at Octopus Investments, people usually set up trusts to make sure assets are kept in the family over generations.

They can be tailored to personal wishes, which gives much greater control over how money is used after it has been given away than making lifetime gifts.

However, higher values settled into trust during a person’s lifetime also take seven years before becoming exempt from inheritance tax.

If someone dies before then, the amounts settled into trust will be included in their estate, and inheritance tax will be payable if the estate is valued at more than the nil-rate band.

There are other charges to consider too, which can make trusts an expensive option and means they may not appeal to everyone.

FOUR AIM STOCKS TO BUY FOR THE INHERITANCE TAX STRATEGY

Shares has taken the same approach as the managers with whom we spoke and screened the AIM market for companies which are profitable, have stable finances and clear growth opportunities.

Chris Boxall at Investor’s Champion has vetted the companies and is comfortable that they currently comply with HMRC rules for inheritance tax relief. 

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Alliance Pharma (APH:AIM)

Price: 93.5p

Market Cap: £499 million

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Unlike traditional pharmaceutical businesses Alliance Pharma (APH:AIM) isn’t exposed to research and development risk because its products are already established. The company outsources capital intensive activities like manufacturing, storage and logistics.

Alliance Pharma has built a portfolio of leading international consumer health brands which have good growth potential supported by scientific efficacy and excellent safety.

Key products include scar treatment product Kelo-cote which is one of the company’s fastest growing products, driven by strong demand from China.

The global medicated anti-dandruff shampoo market is a valued at over $18 billion and demand for the company’s Nizoral product is supported by increasing disposable incomes in China and India.

The company recently entered the US menopausal relief market with the purchase of Amberen which owns the number two brand. 

Alliance Pharma is targeting double-digit revenue and profit growth over the next three to five years.

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Marshall Motor (MMH:AIM)

Price: 178.7p

Market Cap: £137 million

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Marshall Motor (MMH:AIM) is the UK’s seventh largest car retailer and one of only six dealerships that represent each of the top five volume and premium brands.

With a strong presence in southern and eastern England the company is growing market share organically and using its balance sheet resources to acquire dealerships to boost brand presence and regional coverage.

Since joining AIM in 2015 the motor retailer has established a track record of meeting or beating market expectations, no mean feat in a sector which has faced headwinds.

Management puts the performance down to a strong culture, brand partnerships, an in-house technology platform and online presence.

With its scalable platform the group is well positioned to continue to take advantage of a consolidating UK motor retail market. This is not the most liquid share so investors may not be able to buy or sell in the amounts they wish and when they wish.

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CVS (CVSG:AIM)

Price: £20.02

Market Cap: £1.38 billion 

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An operator of animal veterinary practices, CVS (CVSG:AIM) is active in a market with favourable consumer trends which were accentuated during lockdown by increased demand to have a pet.

While the UK population has been broadly stable for the past decade, spending on pets has grown by 7% annually according to investment bank Liberum.

However, Liberum believes the pandemic has created a swathe of new pet owners that otherwise wouldn’t have entered the market, while the change towards working from home could result in higher growth in future years.

As a result, the veterinary practices market could see double the historical growth rates over the next few years. The high barriers to entry and scale advantages enjoyed by CVS puts it in a good position to exploit the growth opportunity. 

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Gamma Communications (GAMA:AIM)

Price: £18.10

Market cap: £1.7 billion

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Cloud-based technology company Gamma Communications (GAMA:AIM) has developed a good reputation for positively surprising investors. In March analysts were compelled to nudge forecasts up in the wake of another stellar year, and that was after upgrades were already pushed through in January.

Outcompeting both large and small rivals for years, Gamma has emerged as something of an AIM star on a strong growth trend, and the Covid-19 pandemic merely hastened the shift of organisations to embrace the cloud flexibility and cost efficiency of the unified communications-as-a-service the company provides.

More than 90% of last year’s record £393.8 million revenue is recurring, and both sales and earnings before interest, tax, depreciation and amortisation increased by 20%-plus. Traditionally UK-only, Gamma has expanded into Europe through sensibly priced acquisitions, accessing markets in Spain, Holland and Germany. Cloud computing penetration is much lower in Europe than the UK and several years behind in technology adoption, meaning there is still a lot of potential growth.

With a strong track record for developing communication solutions, we would expect the company to continue expanding its suite, creating an increasingly compelling value and service-based proposition.

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