With the current nil-rate threshold for inheritance tax being frozen at £325,000 until 2028, many investors will be wondering how they can reduce tax liabilities for their estate when they die.
In the 2021-22 tax year, inheritance tax receipts jumped 14% to a record £6.1 billion as more people’s estates topped the threshold, yet according to a survey by estate planning firm Time Investments only 22% of those in the 55 to 64 age-bracket knew what their estate’s inheritance tax liability would be.
An even smaller percentage, just 8%, said they had taken action to ensure their estate didn’t pay any more inheritance tax than was needed.
INVESTING IN AIM STOCKS TO MINIMISE IHT
One popular way to minimise inheritance tax bills is to invest in AIM-quoted companies which qualify for business property relief.
Business relief, as it is now known, was introduced in 1976 to allow family businesses to be passed down through generations free of inheritance tax (also known as IHT). Its scope has since been widened and in 1996 it was made available for a range of assets including shares in some limited companies.
Shares which qualify for business relief are excluded from inheritance tax calculations if they have been held for longer than two years at the time of death and the company still meets the criteria.
There is no upper limit or allowance on the amount of money you can invest, but the problem is there is no official list of companies which do and don’t qualify for inheritance tax exemption, nor is there a ready-made fund which investors can buy off the shelf. Some wealth managers offer AIM IHT portfolio services, but these typically come with high charges.
HMRC has a set of guidelines which determine the type of company that could qualify for relief. They must have a proper trading business such as a pub, a manufacturer or a retailer. To qualify the company must not be listed on a main stock exchange either in the UK or abroad.
The most notable exclusions are companies that mainly deal with investments, land or buildings (for example, real estate investment trusts), and not-for-profit organisations.
Since there is no definitive list of qualifying companies, claims are assessed retrospectively meaning when a claim for relief is made during the probate process HMRC will confirm if the company in which the deceased was a shareholder qualifies for business relief and whether the shares can be passed on free of inheritance tax.
Importantly, to benefit from 100% relief the company must have qualified at the time of the investment and still qualify when the relief is claimed.
You cannot claim business relief if the company:
– Mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments
– Is a not-for-profit organisation
– Is being sold, unless the sale is to a company that will carry on the business and the estate will be paid mainly in shares of that company
– Is being wound up, unless this is part of a process to allow the business of the company to carry on
HOW DO I PICK THE RIGHT SHARES?
One option is to pick companies yourself which qualify for relief and put together a portfolio. This means you will need to research the shares beforehand to establish their investment merit and status regarding relief.
When you contact them, AIM-listed companies should be able to confirm if they think they qualify at that point, but you should check in regularly as a company which qualifies today may not qualify in future.
The easiest starting point may be to make a note of which companies don’t qualify for relief using a simple checklist.
The Government website provides further information. It is also worth visiting the Investor’s Champion website as it has a screening tool which is regularly updated to help identify AIM companies which qualify for relief from inheritance tax. There is a small fee to pay for this service.
The important rules to consider
You need to invest in qualifying AIM companies for at least two years to get the inheritance tax relief.
The clock starts ticking from the point at which your money is invested in qualifying stocks.
If you make a second (or more) deposit of funds, a new clock starts for that amount of money – so you’ll need to keep accurate records as your investments would now need to be held over different time durations.
If you sell the stocks after the two-year qualifying period ends, you have three years to use that cash as you wish – but you must be reinvested in qualifying stocks by the time that three-year period ends.
You must be invested at the point of death.
Speak to a qualified tax expert to get full clarification of the rules.
WHICH KIND OF COMPANIES QUALIFY?
Below are three examples of well-known AIM companies which qualify for inheritance tax relief, as suggested by Chris Boxall from Investor’s Champion and Fundamental Asset Management, which offers AIM IHT portfolio services.
JET2 (AIM: JET2)
Travel group Jet2 offers low-cost travel through its airline, Jet2.com, the UK’s third-largest carrier, and package holidays through Jet2holidays, the country’s second-largest package holiday provider.
Jet2 is AIM’s third-largest company with a market value of £2 billion. Founder and executive chairman Philip Meeson owns 20% of the group’s shares.
Half-year results reported on 24 November saw Jet2 swing to a £450.7 million pre-tax profit versus a £205.8 million pre-tax loss a year earlier. Those profits are well ahead of pre-Covid days thanks to pent-up demand for travel, greater capacity to fly customers abroad and a greater percentage of sales coming from higher margin package holiday customers.
Higher fuel and staff costs could put pressure on margins near-term and there is also uncertainty around whether as many consumers will be able to afford to go on holiday next year versus 2022. Yet Jet2 is big in all-inclusive package holidays, and these might appeal to people who want certainty over how much their trip abroad will cost in total, rather than simply securing a plane ticket and a hotel, and then realising the food and drink is costing them a lot on top.
CVS Group (AIM:CVSG)
CVS is one of the largest integrated veterinary services providers in the UK, with over 500 veterinary practices across the UK, Ireland and the Netherlands.
Alongside the core veterinary practices division, CVS also operates laboratories, pet crematoria and an online retail business. It is currently AIM’s seventh-largest company with a market value of £1.4 billion.
CVS plans to double profitability over the next five years through a combination of higher organic growth and improved margins through investment in facilities and equipment.
Acquisitions will remain part of the growth story and are expected to see CVS achieve a bigger position outside of the UK in time.
A trading update on 23 November said the company had enjoyed a positive start to its new financial year with performance for the four months to 31 October in line with expectations.
RWS (AIM:RWS)
Founded in 1958, RWS is a world-leading provider of technology-enabled language, content and intellectual property services.
The group’s customers include 90 of the world’s top 100 brands, the top 20 pharmaceutical companies and 19 of the top 20 patent filers.
RWS is AIM’s ninth-largest company with a market value of £1.3 billion. Executive chairman Andrew Brode holds 23% of the shares.
On 26 October, RWS reported a year-end trading update, guiding for 8% revenue growth and in line with market expectations. Some of its big technology customers have reduced activity over the past year but RWS is confident that volumes will recover ‘in due course’.
The shares have also been caught up this year in the rotation away from highly rated growth stocks and more towards value. A year ago, investors were happy to pay 30 times earnings for the stock, but today the shares only trade on 13-times.
WHICH COMPANIES DON’T QUALIFY?
The list below, also suggested by Chris Boxall, comprises firms which don’t meet HMRC’s requirements, although they may have done in the past.
Abcam (ABC:AIM)
Abcam is a global supplier of life science research tools and AIM’s largest company with a market value of £3.1 billion.
It used to be a popular stock for IHT planning portfolios, but the listing of its American Depositary Shares on the Nasdaq market in October 2020 compromised its IHT qualification, causing many AIM IHT managers to sell the shares from portfolios they managed.
Unlike AIM, the Nasdaq meets HMRC’s definition of ‘listed’ for the purpose of HMRC legislation although there is a degree of ambiguity as strictly speaking it is the ADS rather than the AIM shares which are listed on Nasdaq.
However, the company recently announced its intention to cancel its admission to trading on AIM so it would no longer qualify anyway. It will delist from the UK stock market on 14 December.
Hutchmed (China) (HCM:AIM)
The ordinary shares of novel drug discovery firm Hutchmed trade on AIM as well as on the main board of the Hong Kong Stock Exchange, which meets the definition of ‘listed’ for the purpose of HMRC legislation. Hutchmed also has a listing on Nasdaq in the form of American Depositary Shares.
Greencoat Renewables (GRP:AIM)
Energy infrastructure investment firm Greencoat Renewables owns a portfolio of more than 1,028MW of power generation assets across Europe.
The company is classed as an externally managed alternative investment fund as it has no employees of its own and is managed by Schroders Greencoat, an experienced investment manager in the listed renewable energy infrastructure sector.
Therefore, as its primary purpose appears to be making or holding investments, Greencoat doesn’t meet the IHT qualifying rules.
OTHER THINGS TO CONSIDER
Anyone investing in AIM shares for the purposes of lowering their inheritance tax liabilities should bear in mind the rules can change.
With the Government under pressure to improve its finances, it is possible that the loophole which allows investors in AIM stocks to benefit from relief could be scrapped one day.
Also, the fact that shares in a certain company qualify as a tax-efficient investment shouldn’t be the prime reason for buying them.
Investors need to do their research and put the fundamentals first, so you need to ask if it is a good business and will it generate an attractive risk-adjusted return over the long term?
Four other ways to reduce inheritance tax
Gifting
Gifting is one way to pass on assets to your children and grandchildren without them paying inheritance tax. However, if you die within seven years of making a gift, inheritance tax will be payable on a sliding scale.
Note that everyone can gift up to £3,000 of their assets to beneficiaries each tax year without that sum becoming liable to inheritance tax, no matter when they die.
Gifts of up to £5,000 to children made in advance of a wedding are protected from IHT, irrespective of when you die, and up to £2,500 for grandchildren. You are also allowed to make gifts from your surplus income, provided they are regular and documented. The rules around this form of gifting are complex, so consider talking to a qualified financial adviser if you are going down this route.
Consider pensions
A pension or SIPP (self-invested personal pension) is a way to pass wealth onto younger generations, though its purpose first and foremost is to provide you with a retirement income.
You can nominate beneficiaries for your pension in the event of your death, which must be officially submitted to your pension provider, and IHT is not generally payable.
If you die after the age of 75, your beneficiaries must pay income tax on money they take out of the pension, which could be 20%, 40% or 45%, depending on whether they are a basic, higher, or additional rate taxpayer.
Set up a trust
Setting up a trust to hold your assets is another option to consider, yet it is complex so consider talking to a financial adviser. The benefit is that whoever you appoint as the trustee can control the assets, rather than them being passed onto the beneficiaries right away.
Buy insurance
Another option to consider is setting up an insurance policy which pays out when you die and thereby covers any inheritance tax liability.
The policy should be written in trust, so the pay-out doesn’t fall into your estate and therefore be subjected to IHT itself. Consider using a financial adviser for this route.
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