- It’s 10 years since the AIM ISA was introduced in August 2013
- But poor returns from the AIM 100 index over the last decade mean investors would have been better off investing in a global fund and taking the IHT hit
- Hazy HMRC rules mean AIM investors face Schrodinger’s tax bill
- The AIM market is risky, but the IHT benefit might be worth exploring with part of a portfolio
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“It’s now 10 years since the government allowed AIM shares to be held in a stocks and shares ISA, allowing investors to protect themselves from inheritance tax, as well as capital gains and income tax. That’s because many AIM companies, though not all, are free from inheritance tax if held for two years or more, under business property relief rules that are designed to encourage entrepreneurship and investment in small companies. Tax reliefs available to investors are valuable things, especially with the government raking in record inheritance tax receipts in June of this year. But using AIM stocks to mitigate inheritance tax is a strategy that needs to be handled with care, whether it’s used inside or outside an ISA.”
Weak AIM performance has offset IHT benefits
“Returns from AIM over the last decade have been Hollywood and bust, reaching a crescendo in 2021 and then dramatically falling back again. Over the last 10 years as a whole, AIM has underperformed the FTSE All Share and the FTSE Small Cap. Like all UK indices, it’s also fallen well behind the global stock market too (as measured by the MSCI World Index). After factoring in the potential IHT to pay, an AIM portfolio has still come out just ahead of the other UK indices. But the IHT benefit has been severely eroded by weaker performance.
“Indeed, when compared to the average global fund, the IHT benefit has now been entirely offset by lower returns over the last 10 years, as the table below shows. So early AIM ISA investors would have been better off investing in a global fund and taking the IHT hit, rather than plumping for AIM shares. This is of course plain to see only with the benefit of twenty-twenty hindsight, but it should give investors pause for thought when constructing their portfolio, especially when considering the additional risks of investing in AIM.
“However there have been times in the last 10 years when the AIM market posted better performance, and with the IHT protection on top, investing in this market would have added a great deal of value to investors’ estates. The high point of the market was in August 2021, when an AIM ISA invested in 2013 would have been worth £209,472. A comparable investment in the average UK smaller companies fund would have been worth £262,714 at that time, but only £157,628 after 40% inheritance tax. The average global fund would have been worth £241,833, but only £145,100 after inheritance tax. In both cases the IHT benefit is partially offset by weaker performance from AIM, but there was still a chunky advantage to holding an AIM portfolio on death between 2015 and 2022. Of course, death and taxes may be certain, but their timing is not, and AIM investors can’t simply choose to cash in their IHT benefit at an opportune moment when the market is flying high.
Source: AJ Bell and Morningstar total return in GBP
“Overall these figures show that the IHT protection afforded by an AIM portfolio has been very valuable at times, but that tax advantage can be offset by investment performance. This highlights the potential shortcomings of letting the tax tail wag the investment dog. Investors with large IHT liabilities to manage should still consider using AIM stocks to mitigate any tax bill for their beneficiaries, but not to the extent that their portfolio is bent out of shape and too heavily reliant on London’s junior market.”
Schrodinger’s tax bill
“The inheritance tax relief on AIM shares is itself is also somewhat problematic. Partly that’s because the IHT rules say AIM companies qualify provided they don’t mainly deal in shares or land, but HMRC doesn’t provide a definitive list, so there’s always that niggling feeling of doubt. HMRC provides business property relief on a case by case basis, which doesn’t provide much assurance. Investors therefore face Schrodinger’s tax bill on death. When the executors open the box containing the AIM portfolio, there may or may not be a hefty inheritance tax charge to pay.
“Investors should also consider the potential for IHT relief to be withdrawn from AIM shares, especially in a tough fiscal climate and with a new government potentially waiting in the wings. Withdrawal of tax protection would leave AIM investors potentially facing a double whammy of losing their IHT protection and seeing their portfolio value sink at the same time. That’s because any such tax move would likely see big withdrawals being made from the AIM market. There’s no suggestion at the moment that politicians of any stripe are considering this, but investors should be alive to this possibility, however remote it may seem.”
AIM: a risky business
“AIM is the London Stock Exchange’s junior market and doesn’t have as stringent rules on listing or reporting as the main market, which leaves investors vulnerable to a greater risk that companies can provide misleading statements. London’s junior market is also home to smaller, early stage companies, which makes them exciting and dangerous in equal measure. There are some larger businesses on AIM, like Jet2 and Fevertree, which are big enough for inclusion in the FTSE 250 if they chose to list on the main London stock market, but they are the exception rather than the rule. The market capitalisation of the average AIM stock is just £27 million, which compares to an average of £233 million amongst the constituents of the FTSE Small Cap Index of small companies listed on the main market. That said, there are around 200 companies with a market cap of over £100 million on AIM, roughly the size which would get them into the FTSE Small Cap index if they were on the main market, so it’s possible to put together a portfolio of AIM stocks that are simply small, rather than microscopic.”
Does stock selection hold the key?
“Of course, like any market there have been some fantastic individual performers within AIM over the last 10 years. Looking at some of the better-known names on the market, the share price of AB Dynamics is up 1570% over the last decade, YouGov has increased by 1330% and Jet2 is up 322%, according to SharePad data. But at the other end of proceedings there are companies which have lost investors most, if not all of their money. So AIM is definitely a market to approach with a line and rod rather than a trawling net. You also need to remain vigilant for companies graduating to the main market, in which case the IHT protection expires, unless you switch to another qualifying AIM stock before this happens. If doing this outside an ISA you need to take into account any capital gains tax liability which may arise when selling your old holding.
“Experienced investors may be willing to take on these tasks themselves, though many will be tempted to leave this to a professional manager. There are a number of smaller companies funds which invest in AIM, but these don’t benefit from IHT relief. That’s because investors must hold AIM stocks directly in order to qualify. There are a number of wealth managers out there who offer AIM portfolios which are professionally managed, but each stock is held in the investors own name rather than through a fund. This means they should qualify for protection from IHT, though as you might expect this is a much more costly service, often in the region of 1.5% to 2% per annum, sometimes with initial charges levied to boot. Investors therefore need to consider the extent to which the investment management is worth these additional costs, and to what extent they are going to eat into their IHT benefits over time.”
