Tax benefits and AIM investing
4 July 2018
AIM is a market where good stock selection can add a lot of value and clients can take advantage of tax reliefs too. But there are caveats, says Matt Hoggarth, head of Research, Thesis Asset Management
As a market for smaller and growing companies, AIM provides an important source of capital for businesses that are expanding, innovating and creating value and jobs. Tax reliefs are provided to encourage investment in these companies.
Shares in an unlisted company are eligible for 100% business relief from inheritance tax (IHT), once they have been held for two years. This includes companies which are quoted on AIM, as long as they do not also have a full listing on another stock exchange. The business must not be involved primarily in trading or holding property or investments, and care needs to be taken over joint venture income or significant balance sheet assets. Despite the two year qualifying period, portfolios can be actively managed, as one business asset can be replaced by another without losing the IHT relief, as long as the combined holding period covers at least two of the last five years.
AIM shares that do not have a full listing elsewhere are exempt from stamp duty. AIM shares are also eligible to be held in an ISA, sheltering them from income tax and capital gains tax. This gives a very attractive combination of an investment that is income tax and CGT free, and after 2 years becomes IHT free.
An investment should not be motivated primarily by its potential tax advantages. AIM shares are potentially highly volatile and investors must be sure that they are comfortable with the risk and return profile. They also need to be aware of the possibility that tax advantages could be removed or changed in future, as this could cause a fall in value.
Managing an AIM portfolio
Only 45% of AIM stocks are profitable and only 30% pay a dividend. Picking the right stocks is therefore crucial. This is a market where good stock selection can add a lot of value.
Companies quoted on AIM tend to be smaller and at an earlier stage in their development compared to those listed on mainstream markets. As a result companies can have shorter track records, less diversified business models or narrower geographical scope than more mainstream equities. There is also less coverage by research teams at banks and brokers. This creates opportunities for investors that are willing to do the analysis, but means that a focus on the details of a company and its profitability is needed. Most investors will want to avoid anything too speculative, but will also be wary of some safer or household name stocks which trade at extremely high valuations, pushed up by tax-motivated investors looking for a safe home for their cash. The middle ground contains many interesting companies with good prospects however.
Solid knowledge of the eligibility criteria for business relief is also required. It is sensible to be relatively conservative when interpreting the rules, as HMRC will only adjudicate on whether a stock is eligible for business relief after an IHT return is submitted, by which time it is too late to make changes. Holdings also need to be monitored carefully after purchase for news that could affect their eligibility for business relief. For example if an AIM company is taken over by a company with a full stock market listing and investors receive shares as part of the transaction then the IHT relief is lost. Even if another AIM stock is bought, a new 2 year holding period begins. Instead care must be taken to sell the original holding prior to the takeover to preserve eligibility.
Liquidity can be challenging on AIM. The order book is not as deep as on the main market, and large orders can take time to fill. Some attractive companies are still held mainly by their founders, so relatively few shares change hands. Low liquidity need not be too problematic for long-term holders, but AIM investors need to be comfortable that they may not be able to sell their holdings instantly. In times of markets stress it may not be possible to trade at all.
Greater bid-offer spreads than main market equities and lower liquidity mean that the impact of buying and selling can be significant. Investors should avoid over-trading. This can be a useful discipline in any case. With many AIM companies at a rapid stage in their growth, it can be sensible to run your winners and not take profits too early.
Time out of the market should also be avoided, because there is no protection from inheritance tax for the part of the portfolio that is in cash. In order to limit the cash balance it is a good idea to do any trading in a phased manner, rather than waiting for all sales to complete before starting purchases.
AIM has been described as the last great stock-picker’s market. With the right expertise and sufficient risk appetite there is the potential to make good profits, but investors must not be seduced by the tax benefits unless they are prepared to accept the volatility that comes with them.
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