It never made sense to exclude AIM stock from ISAs. Allowing AIM shares to be included into the ISA allowance was long overdue. The UK tax reliefs available on investment, originally the PEP and then the ISA, have always been aimed at encouraging investment and what better than to encourage investment in smaller companies?
The one potential disadvantage of an ISA is that it offers protection against UK lifetime taxes but not against UK inheritance tax (IHT). Although this is not necessarily a concern for those who are no longer UK domicile, for those who remain so, and therefore subject to IHT on worldwide assets, this remains an important issue.
The rule change paves the way for the IHT-free ISA – since qualifying AIM stocks benefit from Business Property Relief (BPR) which provides an IHT exemption once held for two years. Investors holding these stocks in their ISA for the two year qualifying period should benefit from virtually no UK lifetime taxes and no death taxes either.
Business Property Relief (BPR) is a relief for transfers of business property and applies to worldwide property held by a UK resident. The business property has to be owned for two years before it can qualify for the relief. This relief exists to enable family businesses to be preserved intact and passed down through the generations.
Business assets that qualify for relief are generally trading assets. For example, BPR does not apply to businesses that consist wholly or mainly in dealing in securities or shares, land or buildings or investments. This is important when considering AIM stock for IHT planning.
The qualification status of a business can change. For example, cash in a business may not be deemed to be a genuine business asset unless it is being held as a short-term deposit for reinvestment into the business. Cash balances may therefore not qualify for BPR and thus be liable for IHT, despite the business as a whole qualifying.
Aside from cash, assets held within a business will be disregarded if they have not been used in the business within the previous two years or will not be required in future for trading purposes.
BPR is only available if there is no binding contract for sale at the time of the transfer. For example, if there is a contract to sell company shares and remaining shareholders are obliged to purchase the shares on death then BPR does not apply. This is circumnavigated in shareholder and/or business protection by use of a cross-option agreement where there is no binding contract for sale.
Relief is available at 100% for:
- Interests in unincorporated businesses i.e. for sole traders and partnerships.
- Share holdings of any size in unlisted and Alternative Investment Market (AIM) companies.
The relief is 50% for:
- Controlling shareholdings in fully listed companies (i.e. more than 50% of the voting rights).
- Land, buildings, plant or machinery used wholly or mainly in connection with a company controlled by the transferor or in connection with the partnership in which the transferor was a partner.
New ISA regulations
The new ISA regulations that came into force from the 5 August ’13 mean ISA wrappers can also now hold company shares which are traded (rather than listed) on any market on a recognised stock exchange. The LSE is a recognised stock exchange but AIM is not, however, as AIM comes under the LSE, AIM stock now qualify for ISAs.
The BPR rules define unquoted as not listed on a recognised stock exchange and so AIM stock in ISAs potentially qualify for BPR.
The attraction of AIM stock in ISAs is clear: hold shares in a virtually tax-free wrapper which becomes inheritance tax free on death, without the need to make gifts or lose control of the money. The legislation change was subtle, but potentially far-reaching.
In an unexpected boost to this rule change, those holding AIM stock outside of an ISA who now switch them as a Bed & ISA transaction into the ISA wrapper, retain the full qualification period, despite there being a sale and repurchase from a capital gains tax perspective. Normal ISA limits apply to these Bed & ISA transactions.
The ISA allowance is modest at £11,520 for UK residents (or £23,040 per couple) yet existing ISA assets, potentially substantial, can also be invested in AIM stock. Identifying which stock qualifies will be an initial and on-going portfolio management issue.
Hence the launch of the first bespoke IHT AIM ISA portfolio product. Alongside generating decent returns, the investor relies upon the portfolio manager to stress test the qualification of the stock they invest in.
Initial trading in AIM stock increased in August compared to the three months to July. In my view the numbers of investors who will actually use AIM stock as an inheritance tax (IHT) planning tool will be a small minority. I’ll explain:
The nature of AIM
AIM stocks are generally a higher risk investment than traditional blue chip shares or funds. Particular issues with the AIM include:
- Less regulation than those listed on the FTSE – potentially poor corporate governance.
- Regular de-listings – companies become no longer tradable on the AIM market.
- Wide spreads between the buy and sell price.
- Poor liquidity and high volatility.
- Low dividend yields.
This compares to the typical investor looking at IHT planning.
- Elderly, retired.
- Somewhat risk averse – “I’ve worked hard for this money and don’t want to lose it or pass 40% to the tax man”.
- Looking for income.
- Generally more interested in protecting their capital than growing it or taking more risk.
Therefore AIM stocks are not usually a good fit for these types of investors and I suspect, were it not for BPR most clients would not choose this type of investment.
The key issue here is to always consider the investment merits first and look at the tax benefits as an added bonus, not a reason to invest.
Generally, AIM shares should only be considered by sophisticated investors who are comfortable with the extra risk and have a long-term investment horizon. Investors should only have a small exposure to AIM shares; I suggest no more than 5% of a portfolio.