A great new source of stocks for your Isa

Investors aren’t used to getting good news from the government – so it’s nice to have something positive to say for a change. This week, the Treasury offered a big potential bonus to investors in small stocks. From autumn, for the first time, shares quoted on the London Stock Exchange’s Alternative Investment Market (Aim) will be eligible for inclusion within an Individual Savings Account (Isa). We think this is a real step forward – albeit with one big caveat.

Isas are one of investing’s few no-brainers. You can use your annual allowance – currently £11,520 – to invest in a range of shares, provided they are Isa eligible. The benefits include tax-free dividends (beyond the first 10%, deducted automatically) and no need to pay capital gains tax.

Most mainstream investable assets can be put in an Isa, including shares, exchange-traded funds, investment trusts and even some bonds. This latest ruling means that Aim shares will soon be added to the list. Better still, many (though not all) Aim shares come with an extra bonus that other eligible shares can’t offer – an exemption from inheritance tax (IHT).

How does this work? Well, Aim stocks can avoidIHT under HM Revenue & Customs’ “business property relief” rules. In short, provided you hold “qualifying” Aim shares (a definition that excludes pure investment and property development companies)for a minimum of two years, they escape IHT (even held outside of an Isa). With the IHT rate set at a hefty 40% on estates worth more than £325,000 (although remember that spouses can effectively pool their allowances), that’s a useful extra tax benefit for those likely to be hit by IHT.

As The Daily Telegraph’s Richard Evans notes, “the Treasury’s announcement… means investors will be able to hold shares in a way that is free from income, capital gains and inheritance taxes”. Since Aim shares are already exempt from the 0.5% stamp duty levied up front when you buy other shares, that makes qualifying Aim stocks held within an Isa about as tax efficient as an investment can get.

Of course, there’s a caveat. Before you rush out to stuff your Isa with Aim stocks, do make sure you are not falling into the obvious trap of lettingthe tax break lead your investing. As Hargreaves Lansdowne’s Danny Cox notes, “Aim shares can be very volatile and smaller companies generally are higher risk than the so-called blue chips”. So do your homework first – all the rules of individual stock-picking (test the balance sheet, look for warning signs, understand what ratios are telling you) go double for Aim stocks.