Chris Boxall highlights how investing in the AIM markets can bring important inheritance tax mitigation benefits
Investment in the shares of qualifying companies listed on the London Stock Exchange's junior alternative investment market (AIM) has become an extremely effective, proven and non-contentious inheritance tax (IHT) planning method.
Under legislation introduced in 1996, individual investors in qualifying AIM quoted companies benefit from the rules on Business Property Relief as AIM shares are designated "unlisted". Investment in the shares in 'qualifying' AIM quoted companies held for two years or more gain 100% relief from inheritance tax. The short two-year qualification period and continual expansion of AIM make it an increasingly compelling tax planning tool. Furthermore, investment in AIM quoted companies avoids the costs associated with forming a trust, or the risks associated with gifts, as assets remain under the control of the shareholder.
Relief from IHT is still available when the property that qualified for Business Property Relief i.e. the AIM share, is replaced with similar qualifying assets. This facilitates the sale of shares in one qualifying AIM quoted company and subsequent reinvestment in the shares of another without investors losing the benefit of continued business property relief. Qualifying business property must be replaced within three years of disposal to retain the relief and all the capital must be reinvested.
In response to the compelling IHT planning benefits several specialist portfolio managers and stockbrokers offer dedicated IHT planning portfolio services. The emphasis here is on a 'portfolio' of individual shares, as opposed to a fund because investment must be directly in the shares of the company, and not via a collective vehicle, in order to secure the tax benefit.
AIM is the London Stock Exchange's international market for smaller growing companies. Since its launch in 1995, over 2500 companies have joined AIM raising over £34 billion in the process. Many highly successful AIM companies have subsequently made the transition to the main market of the London Stock Exchange following their success on AIM.
AIM has also been the market of choice for a growing number of international companies as well as household names such as Majestic Wine, Domino's Pizza, Mulberry and Stanley Gibbons, to name a few.
Currently the number of companies on AIM is approximately 1,600, with a large number of good solid business generating excellent profits. Unfortunately the AIM index as a whole has fallen over 30% during the last two years with many, who may have been contemplating AIM investment for IHT planning, probably questioning whether it is wise in the current climate. However, the performance of many IHT planning portfolios has generally been positive over the last three or four years as a whole, with the result that investors have not only made material capital gains but more importantly moved substantial assets outside of their estate for IHT purposes.
It's worth pointing out that the AIM index (of which there are three variants) as a whole is a very poor barometer for the performance of IHT planning AIM portfolios. AIM is dominated by the mining, oil & gas and real estate sectors which contribute over 40% of AIM's market capitalisation (June 2008). While the two resource sectors have generated perhaps the most interest from active traders and institutions, many IHT planning portfolio managers have largely steered clear of these more speculative areas focusing instead on UK based companies with a track record of profitability and cash generation.
From a stock specific basis, and with due regard to their business prospects and ability to generate cash, the valuations of many smaller AIM companies currently look to be at attractive levels relative to their main market peers. For those investors with an eye on the long term, and IHT planning investors fall into this category, there could be some excellent buying opportunities over the coming months.
An ability to protect your capital
Notwithstanding the compelling IHT breaks available when investing in AIM quoted companies, many investors remain wary of AIM due to the more volatile nature of the junior market. There is also the risk of potential loss of capital and the perception that the vast majority of AIM quoted companies are generally small with the shares trading infrequently.
However, the shares of many of the larger AIM listed companies are much more liquid than many imagine meaning that investors can secure quick access to their capital if needed. Even more importantly, the growth in derivative related products, such as contracts for difference, means that there are tools available for investors to protect their capital while continuing to hold the AIM shares, so as to benefit from the two year holding period.
Through using commonly traded derivative instruments, such as contracts for difference, the AIM investor can in theory be protected or hedged against up to nearly 100% of any potential capital loss. The use of hedging tools therefore encourages early investment for the purpose of IHT planning, market conditions notwithstanding.
The flexibility of using investment, as opposed to insurance, related tools in hedging an investor's portfolio also means that investors don't have to be locked in and can 'turn off' the protection at any time and liquidate their portfolio if necessary. As portfolio protection of this type is not insurance based the portfolio manager can also hedge the client's portfolio at a relatively small cost, regardless of the client's age or state of health. Hedging can either be established at inception of the portfolio, at a later date to protect returns at a critical time, or to facilitate more effective capital gains tax planning.
During this period of market turbulence, it's also perhaps worth remembering the maxim of Sir John Templeton, one of the most successful investors of the 20th Century that the best time to invest is at "the point of maximum pessimism"!
Spent 56 years at Schroders
Warns on profits
Hargreave Hale seeking legal advice