This August brings with it a tin anniversary of sorts for the junior market, marking 10 years since the UK government permitted AIM-listed stocks in tax-advantaged individual savings accounts (ISAs).
However, investors who opted to flesh out their ISA portfolios with promising growth stocks may not be enjoying the gains they had hoped for, despite AIM’s inherent tax advantages.
All stocks held in ISA are privy to capital gains and income tax relief, but only AIM shares come with the added bonus of inheritance tax (IHT) relief.
However, recent analysis provided by AJ Bell shows that the IHT benefit exclusive to AIM stocks has been “severely eroded by weaker performance” over the past 10 years” relative to the MSCI World Index.
“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,” noted AJ Bell’s Laith Khalaf.
Though the FTSE AIM 100 and FTSE AIM All Share have underperformed against the wider FTSE All Share, IHT advantages made AIM a better investment proposition in the past decade, assuming IHT exemptions across all stocks (which, as detailed below, is not always the case).
AJ Bell’s data shows that, before IHT, £100,000 invested in AIM 100 and AIM All Share netted £120,757 and £116,572, while the FTSE All Share netted £190,219.
When factoring into IHT, FTSE All Share returns fell to £101,370, with both AIM indexes theoretically should have stayed the same.
On the world stage, investing £100,000 in the MSCI World Index a decade ago would have returned £284,671 pre-IHT, or £170,803 post-IHT, making the global index the best option in hindsight.
“This highlights the potential shortcomings of letting the tax tail wag the investment dog,” said Khalaf.
“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
Investing in growth companies is inherently risky, but AIM-listed plcs come with their own unique layer of risk.
Though many AIM stocks are IHT-exempt under Business Relief (BR) standards, HMRC doesn’t provide a definitive list. Rather, the tax office provides BR guidance on a case-by-case basis.
“So there’s always a niggling feeling of doubt,” said Khalaf. “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.”
Furthermore, companies may have their IHT-exempt status withdrawn at any moment.
Khalaf explained: “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.”
The likelihood of this happening is slim but remains a risk factor regardless.
The moral of the story?
Though AIM ISA offers potential IHT benefits, it's clear that investors need to approach it with caution and a well-informed strategy, and the past decade has shown that tax benefits alone cannot compensate for weak market performance.
As Khalaf stated: “AIM is definitely a market to approach with a line and rod rather than a trawling net.”