New rules allowing investors to shelter more cash from the taxman are set to take effect amid fears that some will be tempted into putting their savings at risk.
Shares in companies listed on the alternative investment market (Aim) will be eligible for inclusion in tax-efficient individual savings accounts (Isas), under changes coming into force on Monday.
The tax break is a government bid to encourage greater investment in small and medium-sized companies and in the process deliver an economic boost.
More than a thousand firms from a broad range of sectors are listed on the market, among them Scottish stocks including Scotgold Resources, Bowleven, IndigoVision and Celtic FC.
Aim shares already mitigate against inheritance tax (IHT) as they benefit from business property relief (which exempts Aim shares from IHT once they are held for two years or more).
Now their popularity is set to soar with the ability to hold them in Isas, which provide shelter from income tax and capital gains tax (CGT).
Adrian Lowcock, senior investment manager at Hargreaves Lansdown, welcomed the move. “Allowing Aim shares to be included in the Isa allowance was long overdue. The tax reliefs available on investment, originally the Pep and then the Isa, have always been aimed at encouraging investment and this change to the rules continues this theme.”
However, while Aim stocks are not start-ups, their size can make them more risky than larger companies, while the lack of research on the firms can mean that for ordinary investors it is a step into the unknown.
“Aim shares are high risk and can be very volatile even over a short time period and not suitable for everyone,” said Lowcock.
Consequently investors letting the tax tail wag the investment dog could be in for a nasty shock if things take a turn for the worse.
Lowcock urged investors tempted by the Aim tax break to carefully consider their investment approach and objectives before diving in.
“I would hope that mainstream investors generally avoid getting sucked into investing in Aim shares even though there might be some temptation,” said David Thomson, chief investment officer at VWM Wealth in Glasgow. “It should really only be for experienced investors prepared to take on a significant risk.”
So who can benefit from using their annual Isa allowance to invest in Aim companies?
Those most suited to Aim are investors who are familiar with the company they are investing in, according to Thomson, including owners and employees who would have bought shares even without the Isa tax benefit.
“This new eligibility will also be popular with those investors who are prepared to speculate with part of their portfolio,” said Thomson.
With greater risk comes greater potential reward, however, and their tax-efficiency can enhance the eventual return.
“The main advantage of investing in Aim shares via an Isa is that if the shares perform very well there will not be any CGT to pay,” Thomson pointed out.
“But bear in mind that with annual Isa limits of £11,520 and annual CGT limits of £10,600 the shares would have to perform very well each year before CGT would be payable – so for most people, unless they have a large portfolio this would not be an issue.”
There are some retail funds that invest in Aim companies, including the Marlborough UK Micro Cap Growth and the Cazenove UK Smaller Companies. However, while such funds offer an alternative to investing directly in Aim shares and can be held in Isas, they do not come with the IHT exemption.
And the new rules supply another angle in the risk-reward equation, with experts predicting a flood of new money piling into (typically illiquid) Aim stocks.
“It often takes a tidal wave of new monies to move markets significantly, but in Aim a ripple can make a large difference,” said Kris Barclay, of Charlotte Square Investment Managers in Edinburgh.
“We have been capitalising on the fact that the larger and more liquid investments listed on Aim will likely attract the majority of new monies from bigger, national players who are effectively forced buyers of such assets due to their liquidity constraints.
“We are not convinced there is longevity in this strategy but as a short-term technical trait, we will certainly expect to benefit and re-evaluate as the bubble in these specific stocks grows.”