Advertorial: Inheritance tax, ISAs and the Alternative Investment Market

Q. Why are ISA investors turning towards the Alternative Investment Market?

A. According to HMRC, there are 21.7 million adult ISA holders in the UK today, holding more in cash ISAs (52%) than stocks and shares ISAs (48%). But some high street banks are now paying just 0.01% interest to instant access cash ISA customers. And thanks to the Personal Savings Allowance introduced in April, the first £1,000 of interest earned by basic rate taxpayers (£500 for higher rate taxpayers) is completely tax-free anyway.

It is three years since shares listed on the Alternative Investment Market (AIM) became eligible for inclusion in Individual Savings Accounts (ISAs). An ISA invested in AIM-listed stocks may appeal to investors who are happy to take additional risk with their investment in order to pursue growth within an ISA wrapper. It’s no surprise that investors are looking towards AIM in the hope of getting their ISAs to work harder.

AIM has matured a lot over the years. Ten years ago, companies making an AIM initial public offering had an average market capitalisation of £17 million. Today, the average is nearer £75 million. Well-known brands such as Hotel Chocolat, Joules and Comptoir Libanais have all floated on AIM in recent months, and it will continue to attract very profitable, successful businesses. Successive governments have remained supportive of AIM, and AIM is increasingly popular with ISA investors, with Self Invested Personal Pension (SIPP) holders and even with institutional investors.

Q. Is inheritance tax planning another selling point for AIM?

A. Most ISAs are subject to inheritance tax. So, someone wanting to leave their £100,000 cash ISA to their children or grandchildren could land them with a £40,000 inheritance tax bill. But some AIM-listed companies qualify for Business Property Relief (BPR). Upon the investor’s death, shares that qualify for BPR can be left to beneficiaries free from inheritance tax as long as the shares have been held for at least two years at that time. Transferring existing ISA holdings into a portfolio of BPR-qualifying companies listed on AIM could prove to be an effective way to ensure an ISA lives up to its tax-free billing – before and after death.

Including BPR-qualifying investments as part of estate planning means clients retain access to their investment, freeing up their options somewhat. They can look to build capital value free from lifetime taxes, choose to take a regular income, or dispose of their holding should their circumstances change. The ability to transfer share ownership between spouses, following the death of the first spouse, without ‘resetting the clock’ on the two-year BPR qualification period, is another key benefit.

Q. Can you describe your process for selecting AIM stocks? 

A. We create growth portfolios, featuring solid predictable businesses, for clients with an appetite for equity risk. The average market capitalisation for our portfolio companies is over £400 million. These are businesses that are quite established. We don't trade in and out of AIM companies, but look to become long-term ‘co-owners’. Of the 47 companies we currently hold within our AIM inheritance tax portfolios, we have been investors in more than half for ten years or longer, sharing in their growth journey. 

Q. Should investors be considering active or passive investments in AIM?

A. Active management generates most value when an asset class is inefficiently priced. This is certainly the case with smaller companies where a lack of research and market coverage creates pricing inefficiencies, which are typically exacerbated following a period of volatility. Expertise and a focus on smaller company, AIM-listed shares creates the opportunity for significant outperformance, and active management can bring the potential of AIM to life for investors.

When it comes to inheritance tax exemption, it is worth noting that BPR is not available on every AIM-listed company. Therefore, it makes sense to choose a fund manager who specialises in this sector. The necessary due diligence requires time, resources and experience. It’s in the nature of smaller companies that not all of them will survive. Investing via a dedicated AIM-focused portfolio is likely to alleviate some of these concerns.

Q. What are some of the risks that advisers need to consider?

A. It’s important to be upfront about the risks associated with investing in AIM-listed companies. Capital is at risk and investors may not get back the amount invested. In addition, companies listed on AIM involve more risk than those listed on the main London Stock Exchange. Their performance tends to be more volatile, which means their value can fall or rise by greater amounts on a day-to-day basis. No matter how well an investment or market may have performed in the past, this is not a guide to its future returns. It’s important to understand that inheritance tax exemption is assessed by HMRC on a case-by-case basis when an investor dies. Until this happens, it cannot be stated for certain that a particular company, or even portfolio of companies, will qualify for BPR.

Q. How experienced is your Smaller Companies team?

A. The team manages approximately £1 billion, and has been managing BPR-qualifying AIM portfolios for more than a decade. We’ve witnessed AIM attracting larger, more established companies looking to list. This means that for us, the pool of potential investments – profitable, established, dividend-paying growth companies – has perhaps doubled compared with five years ago. Offering investors an estate planning solution within a tax-efficient ISA wrapper has proven very popular. Since we launched the Octopus AIM Inheritance Tax ISA in 2013, we’ve opened more than 4,000 portfolios on behalf of investors.

Q. What’s your outlook for AIM, especially in light of the Brexit referendum?

A. Recent trading statements from portfolio companies suggest management teams remain confident about their future prospects. Around half of the companies in our AIM Inheritance Tax Service portfolios earn more than half of their earnings overseas, so the recent weakness in sterling has been a benefit. Moreover, the risk of investing in AIM-listed smaller companies can be reduced by taking that long-term time horizon, which people naturally do with our inheritance tax planning investment services. A number of the companies we invest in have been around for over 100 years, and there’s a good chance they will be around for another 100 years.

Important information

For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the portfolio companies maintaining their qualifying status. The shares of the smaller companies we invest in could fall or rise in value more than shares listed on the main market of the London Stock Exchange. They may also be harder to sell. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation. These products are not suitable for everyone. Any recommendation should be based on a holistic review of your client's financial situation, objectives and needs. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Investors should read the product brochure before deciding to invest. This is available at octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: November 2016