Should you buy AIM shares to reduce inheritance tax?

My late father-in-law invested in some AIM shares as an approach to reducing inheritance tax.

Unfortunately, he died before the majority of the investments had reached the qualifying two years.

We understood that in this case his estate must pay the tax he was trying to avoid. This was mentioned in the brochure from the company through which he bought his shares.

Sorting out an estate: Should you buy AIM shares to cut how much inheritance tax your heirs have to pay (Stock image)

However, what it failed to mention, and what we subsequently learned when the Covid-19 market crash happened, is the tax on AIM shares in this scenario is based on their valuation at death, even if they become worthless while you wait for probate.

So, the estate is still on the hook for all that tax determined by the valuation, with no recourse to making a claim for loss relief by selling them within a year.

In essence all you can do is to hold on and hope for a recovery, which is what we have done. The market luckily recovered enough to bring the value back to within a few thousand pounds of the original inheritance valuation, at which point we headed for the door.

However, I dread to think of what could have happened had everything and the kitchen sink been used to buy AIM shares on the assumption there was no hidden downside risk and then the market had failed to recover. 

I’ve obviously ignored the capital gains tax position, so if the assets were transferred and not sold, a capital loss as I understand it could then be claimed based on the probate valuation sometime later on.

However, inheriting a massive capital loss isn’t normally something most people I think would have a great deal of use for.

I approached the firm which sold the AIM shares to my father-in-law and asked why it didn’t explicitly highlight this particular risk in their documents, given it would appear to me to be worth knowing about.

I was effectively told they can’t put in every risk, only the main ones.

Should this issue be flagged and stronger warnings given to people who buy AIM shares to mitigate inheritance tax?

Tanya Jefferies, of This is Money, replies: Owning shares in firms with ‘business property relief’ status can give people protection from inheritance tax if they are held for at least two years.

This is how people invest in AIM-listed shares for an inheritance tax-friendly portfolio. 

Some investment firms offer schemes helping people buy shares in the right companies to cut their inheritance bill, and it sounds like your father-in-law could have used one of them.

Investors interested in doing this should bear in mind that businesses qualifying for this relief are at the adventurous and therefore riskiest end of the spectrum.

We asked an estate planning expert to explain how this works and the potential pitfalls, for the benefit of others considering this method of stopping the taxman grabbing more of their estate after their death.

Ian Dyall, technical manager at Tilney Group, replies: AIM shares are often attractive to some investors as they provide relief from inheritance tax after two years and don’t involve giving up access to the money invested.

In contrast, many other strategies for mitigating inheritance tax involve gifting, either outright or into trusts, and typically take seven years to become fully effective.

How does buying AIM shares help reduce inheritance tax?

AIM shares are traded on the Alternative Investment Market and are not classed as ‘listed shares’.

They therefore qualify for business relief after they have been held for two years.

Business relief is an inheritance tax relief available to shareholders of unlisted companies, originally intended to prevent executors having to sell the business to pay inheritance tax after the death of a small business owner.

Ian Dyall: AIM shares are traded on the Alternative Investment Market and are not classed as ‘listed shares’

AIM shares have a number of useful benefits. They are relatively easy to sell, they can be held in an Isa wrapper and some of them are household names, so they feel secure.

However, the investor is investing in smaller, non-listed companies, which means their value is more volatile than FTSE-listed shares.

This is particularly relevant if your investment timeframe is only two or three years, which may be the case if you are buying them for their inheritance tax benefits.

Should you consider buying AIM shares for this purpose – what are the pitfalls?

It is better to think of AIM shares as an alternative form of investment and use them to add spice to a larger investment portfolio.

The inheritance tax benefit should be seen as a useful bonus rather than the prime driver, particularly as that bonus that could disappear if the company decides to list, gets bought by a listed company or legislation changes around business relief.

For most people with an inheritance tax liability, there are other strategies they should be using before considering investments qualifying for business relief, but it is important to start planning early and to take advice about all the options available.

The earlier people start planning the more options they have available, and the less aggressive they have to be with their approach.

The other implication of AIM shares not being listed is that they do not qualify for loss relief in the hands of the executors of an estate.

Inheritance tax is normally based on the value of a person’s assets at the date of their death, but the government has recognised that estates take time to administer and in that time the value of shares and property can reduce in value.

Loss relief allows you to substitute the price those assets are sold for instead of the value at death when equating the inheritance tax liability.

Loss relief on shares is only available on shares listed in the UK or on a recognised foreign stock exchange, and unit trusts.

It is not available on unlisted shares or shares traded on the Alternative Investment Market.

Any claims for relief must include all the shares sold in the 12 months after death, including those that have made a gain, and the relief will be based on the net loss

Details can be found in HMRC’s inheritance tax manual here. 

Should stronger warnings be given to people buying AIM shares for this reason?

From the details you have given about your father-in-law’s purchase of AIM shares, it is not clear whether he took professional advice.

If he did, he is likely to have received a report from the adviser in addition to the company literature.

Most financial advisers will provide fairly detailed reports outlining both the benefits and risks of the advice they provide.

One of the challenges for all advisers is ensuring that the reports cover all the key risks whilst remaining readable.

That is not always easy in what can be a complex area.

To answer your question, I do think that stronger warnings should be given to people who buy AIM shares to mitigate inheritance tax, particularly where it is a sizeable portion of their estate or they have a limited investment timeframe.

Other mitigation strategies should be considered first, and in many cases AIM investments may not be suitable.

This post first appeared on Dailymail.co.uk