Autumn Budget: will AIM shares lose their inheritance tax break?

There has been no shortage of speculation about the contents of the Budget later this month: pension tax relief, the tax-free lump sum and ISAs are among the tax benefits said to be at risk of a shake-up by Rachel Reeves, the Chancellor. Inheritance tax is another and it has not escaped attention that even if Labour leaves the basic structure of death duties alone, one popular way to avoid them could face the axe: the exemption that certain AIM-quoted shares enjoy. Here we explain how the tax break works and outline the possible consequences of any change.

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What are AIM shares?

AIM is the Alternative Investment Market, a part of the London Stock Exchange dedicated to fledgling businesses. The costs for a company of obtaining an AIM quotation for its shares are lower than those of a full listing on the main market of the stock exchange and once on AIM the regulatory burden a company faces is less onerous. AIM shares can, however, be bought and sold via a stockbroker such as Fidelity just like any other share. Well known AIM shares include Fever-Tree Drinks, Jet2 and YouGov.

What is the tax break they enjoy?

Because AIM is intended for immature businesses, investing in AIM stocks is seen as more risky. In an attempt to encourage investors to take this extra risk and so help promote entrepreneurial activity and economic growth, successive governments have offered those prepared to take the risk a tax break: there is no inheritance tax to pay on most AIM-quoted shares passed to your heirs as long as they have been held for at least two years.

The official name for the tax break from which AIM shares benefit is ‘business relief’, which also protects owners of family businesses from inheritance tax bills that might otherwise force the sale of a business when it passes from one generation to the next. AIM shares are lumped in with such unlisted enterprises because, in the eyes of the law, a quotation on AIM does not constitute a ‘listing’.

AIM shares do not automatically qualify for the tax break, however; certain types of business (such as those who purpose is to invest passively in assets such as property rather than to buy and sell goods or services) are ineligible. Because businesses can change their character over time, there is no set-in-stone status for a particular AIM stock when it comes to the tax break and eligibility is determined only when a deceased investor’s portfolio is examined by HMRC for the purpose of establishing the estate’s inheritance tax liability.

Why is the tax break perceived to be at risk?

The Chancellor claims to have identified a £22bn ‘black hole’ in this year’s government accounts and the prime minister has said the Budget will be ‘painful’ for those with the ‘broadest shoulders’, who must expect to bear the burden. As inheritance tax is due only on estates of £1m or more for a married couple (assuming that the family home is passed on to a direct descendant), it can plausibly be portrayed as a tax that affects only the better off. Nonetheless a cut in the tax-exempt amount or an increase in the headline rate, currently 40%, would undoubtedly prompt a political storm so Labour could choose to change some of the more peripheral rules, such as those that apply to AIM shares, in the hope of generating more revenues from inheritance tax.

What would be the consequences of the abolition of IHT exemption on AIM shares?

Of course any scrapping of the tax break is only speculation at this stage so we don’t know how abolition, were it to happen, would be implemented. There could, for example, be transitional arrangements for those who have already invested. But it’s reasonable to suppose that abolition or severe curtailment of the existing tax breaks would result in more selling of AIM shares, which would of course depress their prices. Even those AIM shares that do not qualify for the exemption could be caught up in any bout of selling, although falls in their share prices might be less acute.

Peel Hunt, the investment bank, has estimated that a decision to remove the tax break would cause an initial 20%-30% share price decline across AIM.

While such share price declines would be most unwelcome for those whose hold AIM shares, they could present a buying opportunity for others.

Abolition or watering down of the tax breaks could also make companies less inclined to seek an AIM quotation and cause the market to shrink. Firms currently on AIM could also decide to move to the main market, especially if founders or major shareholders had chosen AIM primarily for the inheritance tax exemption.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.