Financial advisers have reported growing appetite for investing in listed stocks that benefit from business relief, as a way to cut inheritance tax, since the pandemic.
Data from HMRC shows inheritance tax receipts jumped £0.3bn year over year this April to June, to £1.8bn, following a rise in property values and probate fees, the administrative costs for transferring asset ownership.
The latest "bumper tax haul" involved a 14% jump in inheritance tax receipts as government reaped £26.7 billion more in taxes through to July, said Myron Jobson, a senior analyst at Interactive Investor.
Inheritance tax came into sharp focus during coronavirus as more people became aware of their own mortality, one client relationship manager told Proactive.
This has prompted more mature investors, typically in their early seventies or older, to re-evaluate estate planning as they think about options for passing a legacy onto their children.
Business relief
The second most common way of reducing the amount of tax paid to transfer ownership of an estate, below gifting, is through business property relief.
“Inheritance tax receipts continue to needlessly grow and this trend is not set to slow,” Andrew Aldridge, a partner at Deepbridge Capital, said in a statement on Friday.
“Deepbridge’s recent research suggested that business relief investments have become an increasingly common tool used by financial advisers and we expect this demand to continue to grow.”
A crop of investment products targeting business relief among Alternative Investment Market (AIM) stocks are sold by investment managers such as Octopus Investments, Stellar and RC Brown.
Investing in AIM stocks that are eligible for business relief enables investors who would not otherwise qualify for property tax relief through businesses they own to access tax reductions on their estate.
Shareholdings left in a will can qualify for business relief of between 50% and 100%, according to UK government guidelines.
Policy
In July 2019, The Office of Tax Simplification’s investigation into the treatment of AIM shares held for business relief prompted concern that removing that relief could lead to a market sell-off.
This left managers such as Octopus, which runs the AIM Inheritance Tax Service and AIM Inheritance Tax ISA together worth a combined £1.9bn, potentially exposed.
Head of retail investment products at Octopus Investments, Jessica Franks, said of business relief that “every time it’s been changed it’s been expanded” and that “all of the evidence in the public domain has only shown support” for it.
“The Office of Tax Simplification undertook a routine review of Inheritance Tax recently, following which HMT announced no changes to IHT would be made,” she told Proactive.
Business relief has stayed relatively untouched since it was first introduced in 1976, except for an expansion of qualifying assets and a rule change that enabled AIM shares to be held in stocks and shares ISAs.
With a leadership change in view this autumn, that bodes well for investors seeking to reduce inheritance tax (and the AIM market by proxy), notwithstanding any impact of future legislation.
Octopus Investments, which is part of the Octopus Group, manages total investments of £2.5bn across its portfolio of AIM products.
These solutions allow shareholders to gain access to a portfolio of business relief-qualifying assets, which can be held in stocks and shares ISAs.
About two-thirds of its AIM inheritance tax solutions are weighted to the ISA product, Franks said.
“The AIM portfolio is actively managed, meaning the Octopus Investments fund managers work with companies to understand their business plans and are consistently re-evaluating the buy list,” she explained.
“Portfolios are ‘rebalanced’ based on current buy lists—each one is unique.”
Risk
A dedicated team of 12 at Octopus, some of whom have worked on AIM since its inception, screen its AIM investments for "dividend payers" and "predictable" returns, Franks said.
Where AIM inheritance tax solutions differ from life insurance is that investors are buying into the underlying value of the investment, including any company dividends.
“The difference with business relief is it’s an investment, so while if you sell shares before you die you won’t benefit from tax relief, you’ve still made an investment in a business that will have value,” Franks said.
On the flip side, “the inheritance tax benefits will mean little if the share price has gone into freefall”, Nicholas Hyett, investment analyst at Wealth Club, said in a note in March.
The risk of investing in AIM stocks, which saw their combined market value surge over the past 27 years, is traditionally viewed as more conservative than investing in venture capital trusts.
This is due to the underlying maturity of the enterprises listed on AIM compared to the nascent companies’ shares often held in VCTs, which benefit from 30% income tax relief.
In 2022, the AIM market listed about 900 companies with a combined market capitalisation of approximately £150bn.
Wealth Club said in March that there were 30 businesses worth more than £1bn trading on the junior market of the London Stock Exchange.
At AIM's inception in 1995, there were just 10 companies listed on the LSE sub-market with a combined market cap of only £82.2mln, according to AIM Watch.
Unlisted shares can also qualify for business property relief and Octopus manages billions of pounds of investments in unquoted renewables, property and health-care companies through its inheritance tax services portfolio.
According to Wealth Club, the company in which most investors in its inheritance tax services own shares, Fern Trading’s, share price grew 53.1% in the decade to April 2022, equivalent to a 4.35% annual return.