Beating the tax man

As well as the potential to unearth bargains the institutions have overlooked, investing in Small Caps can help you save tax.

AIM is the London Stock Exchanges junior market and tends to attract younger companies looking to expand.

Investing in AIM stocks has significant tax advantages for the private investor. The individual has the benefit of tax breaks that are not available to funds.

In particular the Capital Gains Tax (CGT) treatment is particularly generous. We all have a CGT allowance of £8,200, which means that we can - and should - realise cash profits to that amount during the tax year (April 6th to April 5th).

If you realise more than £8,200 profit from main market shares during the year you will normally have to pay 40 per cent capital gains tax on the additional amount. However, AIM stocks are classified as 'business assets' and therefore, although you will have to pay 40 per cent if you have owned the share for less than a year, there is a tapering system in place which means that the rate falls to just 10 per cent after two years.

Shares in new AIM companies may also qualify for an Enterprise Investment Scheme, which is available to businesses which have gross assets valued at less than £15m before flotation and less than £16m after. In this case you can defer CGT on profits made in the 36 months prior or the 12 months following your purchase of the new shares. You also get 20 per cent income-tax relief on up to £200,000 when you hold the stock for three years or more.

And finally, AIM shares become free from inheritance tax once you have held them for two years.

A note of caution: Don't invest in AIM shares simply for their tax breaks. The market is a haven for fledgling companies that are striving to prove themselves and that means they are riskier than well-established businesses. Be sure to balance risk with reward.