Take Aim at lower IHT bills

Buying equities on Aim, London’s junior stockmarket, can help investors cut their inheritance-tax bills. But tread carefully: small stocks are very risky

Last autumn the government abolished the Health and Social Care Levy, which imposed a small additional tax on dividends. However, chancellor Jeremy Hunt’s (pictured) decision to cut both the tax-free allowance on capital gains and the dividend allowance (which will fall to £3,000 and £500 respectively from April 2024) demonstrates that the broader trend is towards a rise in taxes on investment, to say nothing of the growing clamour for a wealth tax. There has therefore never been a better time to put money in an individual savings account (Isa): any investments inside the wrapper are free of taxes on capital gains, dividends or (unlike with pensions) withdrawals.

However, while Isas are exempt from income and capital gains taxes, they aren’t exempt from inheritance tax (IHT). So your estate could ultimately pay 40% on a sum above the current IHT allowance of £325,000 – or £650,000 for a couple, or up to £1m depending on the value of the family home and who inherits it. Even leaving it to your spouse only defers the bill until they die. With IHT thresholds frozen until at least 2026, even those with relatively modest estates could face a hefty bill. The Office for Budget Responsibility estimates that IHT tax revenue will jump by 9.8% from £6.1bn in the 2021-2022 fiscal year to £6.7bn in 2022-2023. Fortunately, you can trim your

IHT bill without setting up elaborate schemes. One option is to invest in shares listed on Aim, the London Stock Exchange’s “junior” market. Aim was set up in 1995 with more liberal listing rules than the main market in the hope that this would make it easier for smaller companies to raise capital. In order to encourage investors to buy these shares, the government has allowed many Aim shares to qualify for business property relief (BPR).

This means that for tax purposes they are treated like unlisted shares and are thus exempt from IHT, despite the fact that they are far more liquid than unlisted shares. The government initially banned investors from holding Aim shares in their Isas. But in 2013, this rule was reversed; Aim shares were also made exempt from stamp duty. You can therefore enjoy both IHT benefits and wider tax protections by putting Aim stocks in your Isa.

Make sure you read the small print

Before you start looking at Aim-listed companies, bear in mind that you cannot simply buy any old Aim stock. Firstly, you need to have held your Aim shares for at least two years before they become exempt from IHT – this is to encourage longterm investment.

However, you don’t have to hold the same share for two years in a row. You can sell an Aim share held for less than two years and reinvest the money in another within three years of the sale; the total time holding shares must add up to two years. So you could hold one share for one year, sell it, keep the proceeds in your Isa in cash for a year, then buy and hold another Aim share for just a year, and you’d qualify.

An arguably more significant problem is that not all Aim shares are eligible for the IHT exemption, as they don’t all qualify for BPR. According to a 2014 study by Fundamental Asset Management, around a third are excluded. The real problem here is that there is no publicly available list of which Aim shares the taxman deems eligible. Still, the rule of thumb is that eligible companies have to be involved in a “proper business” (so investment trusts and property companies are excluded), and they can’t be listed on another exchange.

Tax-free doesn’t mean risk-free

Even though Aim shares are tax-free when held in an Isa, they are hardly without risk– quite the opposite, in fact. Smaller companies tend to be more volatile and less liquid than their larger counterparts, and they usually come with bigger spreads (the difference between the buying and selling price), which could erode your returns significantly if you buy and sell frequently over a short period. Looser listing standards also mean that there have been several big collapses of Aim companies over the past few years.

However, there have also been some success stories. For example, billing-services firm Cerillion has risen by over 600% since 2018. Another benefit of Aim is that it is more diverse than the blue-chip FTSE 100 index, which is heavily weighted towards resources and financial companies. Aim contains several interesting technology firms, for instance. Furthermore, many Aim stocks are too small for big institutions to analyse or include in their funds, which means that a private investor with decent stockpicking skills and plenty of time has a good chance of spotting hidden gems in the market.

Nonetheless, if you don’t want to spend time working out which shares are eligible for BPR while trying to avoid the duds, you can always get a professional to do the work for you. Although funds and investment trusts that hold Aim shares are not exempt from BPR, many investment managers offer to pick a portfolio of Aim shares eligible for the Isa wrapper on your behalf. Sadly, such services don’t come cheap, with annual fees of 1%-2% of assets and hefty minimum investments (at least £10,000, but potentially up to £50,000) common.

Will these benefits continue?

Note that these tax benefits could change. For example, BRP could be limited to those who own a controlling stake in a company. While it is “extremely doubtful” that the government would change the rules before the next election, in the longer run changes to BPR could be a way to raise revenue “without having to increase income tax charges that are noticeable by the majority of the electorate”, says Steven Rowe, director at Lucent Financial Planning.

If this happened it would be “inevitable” that share values would fall, at least in the short run. So always ensure that you are investing in Aim stocks because they are promising companies, not simply in order to enjoy the tax efficiencies they offer.