Market performance – the AIM index had a brief respite post the budget, but has still underperformed the smallcap market by c.10% since June.
Taxing – we estimate the IHT changes will result in a £1.1bn reduction in tax revenue, rising to >£2bn, which is very different to the HMRC view of a tax raise of c.£100m.
AIM impact – there will be ongoing outflows from IHT funds as a result of these measures, which should continue to weigh on the AIM market.
Government action – AIM is a key market to enable companies to grow and scale, and is a huge fiscal contributor. Investor demand is a crucial component for a successful market and for many reasons there is a clear funding gap on AIM. We urge the government to review its budget measures to ensure AIM is able to function effectively.
Government action and unintended consequences
We understand the need to increase tax revenue and to reform IHT. However, as ever, there are unintended consequences of any changes. In this instance we see two key issues.
- The tax changes will result in a reduction in tax revenue.
- The AIM market is being materially undermined, thus reducing economic growth in the UK.
It is important to note that the changes were made without prior consultation. If we had been asked, we would have warned of the material downside risk of the changes. Our asks for the government are:
- Review the exclusion of AIM investment from the £1m business property relief (BPR) allowance.
- Confirm that the 50% BPR allowance will be retained indefinitely.
- Provide guidance on whether eligible AIM companies in pensions are able to receive the 50% relief.
- Reduce the level of CGT on AIM to stimulate investment into AIM and increase the tax take.
- Assess opportunities to accelerate investment in AIM through the British Business Bank (BBB) and the Business Growth Fund (BGF).
Budget changes to IHT
The summary of the reforms to agricultural and business property relief can be found here.
The key impact on AIM was the change to BPR relief. Previously, investments in eligible businesses were fully exempt from the 40% inheritance tax. This has been changed to 50% BPR relief, equating to a 20% IHT charge vs zero previously, from April 2026. According to HMRC, in a sample of 2021/22 tax returns c.40% of all estates claiming BPR claimed it on AIM shares, which equated to 20% of the value (there were 4,170 claims with a total of £2.85bn in 2021/22). HMRC estimates the tax cost to the Exchequer relating to AIM shares was £185m, which means that the net loss would have been £92.5m on the new basis (given that there will still be 50% relief).
In itself, the 20% tax saving should still be attractive and in theory provide an incentive to investing in AIM companies (which is the policy objective of providing BPR relief). However, the problem is that AIM shares will be excluded from the £1m allowance that is provided to farms, family businesses and private businesses. The rationale makes sense – ie these are seen as assets that are handed down to the next generation unlike most AIM holdings – however, the result is that qualifying private investments are included in the £1m allowance whereas AIM companies are not. The consequence will be that private businesses are prioritised for new investments, and owners of existing AIM investments have an incentive to switch to private in order to save up to £200k in IHT. There will not be many investors that have over £1m available for investment in IHT products given that the typical AIM portfolio is c.£300k.
There is no longer a level playing field between private and public assets due to the £1m allowance (effectively £2m for a couple). We believe this means that wealth managers and IFAs will inevitably prioritise private investments for new IHT funds. As a result:
- New fund flows into AIM for IHT funds will be very limited.
- Outflows from IHT funds will amount to >£600m per annum given the normal lifespan of investors.
- There will be a clear incentive for IFAs to move the existing c.£6bn of AIM IHT funds into private vehicles. We understand that IFAs are already recommending this due to the negative perception of AIM from the budget changes.
- The attraction of AIM is materially lower for those with direct investments.
- Other funds may reduce exposure. In addition, there will be changes in mandates or funds put into voluntary wind-up, such as the recent announcement from Miton UK MicroCap Trust.
- Net outflows from AIM will be material in the context of a market already seeing substantial issues (eg IPO activity is at multi-year lows and there is an unprecedented number of companies exiting AIM).
- There is a clear risk from increased investment in private vehicles, which could both cause an asset bubble and a liquidity risk.
The impact of the changes is that there will be minimal new investments into AIM IHT funds – with money going into private IHT funds instead - whereas there will be continued outflows due to the death of investors in existing AIM IHT funds and switching into private. Looking at the numbers, AIM IHT funds represent c.£6bn of assets in a market valued at £64bn, so c.10% of the total. The average period of ownership for an investor in an AIM IHT fund is 8-10 years, which means that there will be outflows of >£600m per annum as people die. In addition, there will be investors that choose to move assets into private businesses. All of this means that there will be material outflows from AIM for many years to come. Furthermore, there is >£5bn of direct equity investments, which combines founders, families and people doing their own IHT planning, some of which will go private.
If market conditions were more robust, there would be less of an issue. Unfortunately conditions are far from robust. There are many drivers for this, but central issues are the increase in passive investment (which largely by-passes AIM), globalisation of capital and the attraction of the US market. AIM has already underperformed materially and the budget changes will compound the issue.
If we want AIM to survive and thrive, it is essential that capital is attracted and the market performs. The good news is that there are plenty of high-quality growth companies listed on AIM (see this note for examples), so it is the demand side that is the issue.
We urge the government to review the £1m allowance to consider including AIM companies. This should ensure that capital remains on AIM rather than
flowing into private assets. We believe the unintended consequences are substantial if this is not addressed.
It is important for the government to provide visibility and clarity for tax planning, given the material changes to IHT relief in the budget. This is particularly important given the age of the people making the investments, as well as the requirement to hold shares for a minimum of two years to secure the relief. Although the presumption is that there will be no further changes, inevitably there will be speculation in the run up to future budgets. Providing a commitment that the change to 50% relief is once and done is essential for long-term planning.
There has been some comment that AIM shares could be included in pensions and secure BPR relief post April 2027, when pensions are included in a deceased’s estate for death duties. This seems unlikely given that SIPPs are set up as trusts, which means that the SIPP provider is the legal owner. In addition, the IHT for pensions is likely to be based on the overall value of the pension rather than the underlying investments. However, the government could take the view that this would encourage investment in AIM. If this is the case, then providing clarity on this point would be helpful.
The CGT changes (increase from 20% to 24%) provide an additional headwind for investors considering investing in companies on AIM. Furthermore, the combination of the IHT and CGT changes make zero economic sense in relation to AIM. The change in IHT has already resulted in a significant level of capital loss (the AIM market has reduced in value by c.£7bn since June), which will materially reduce the level of CGT being paid (through reducing gains and creating offsetable losses). Given the pressing need to encourage investment in AIM, the higher risk profile of smaller companies and the desire to increase tax revenues, we strongly urge the government to re-look at the CGT level. Given that AIM is a distinct and technically unlisted market, it can be treated differently to the Main Market. Reducing the rate to say 10% for AIM stocks would
stimulate an increase in investor activity, revitalise the market and actually increase the level of CGT paid. This is a great example of where a lower rate would raise more tax.
We have advocated for the government to directly support investment in smaller companies through the BBB and/or BGF. This would provide a strong signal of support for UK capital markets, reverse the current outflow trends in smaller companies, crowd in additional investment, support economic growth, and improve tax collection. The government still owns close to £3.5bn of NatWest and intends to continue to release capital. Injecting this back into smaller companies would reduce concentration risk and provide a spark for share price performance. This would be net neutral for the Exchequer initially and likely end up creating material value for taxpayers.
Rationale for attracting capital to AIM
Grant Thornton undertook a project in May 2024 to assess the economic impact of AIM. The main findings in the report were:
- Funding – AIM companies raised £48bn at admission and a further £39bn in follow-on funding over the 28 years since AIM was created.
- Direct contribution – AIM companies contributed £35.7bn Gross Value Added (GVA) to UK GDP in 2023 and directly supported more than 410,000 jobs.
- Broader contribution – adding in wider economic activity through supply chains and the expenditure of employees increased the economic contribution to £68bn in GVA and 779,000 jobs.
- Scaling up – AIM helps growing business to scale. This can be demonstrated by revenue growth of >40% per annum in the first three years post IPO and growth in number of employees of 17% per annum.
- Growing profits – average profit grew from £2m in 2010 per company to over £13m in 2023.
- Tax take – AIM companies made a corporation tax contribution of £5.4bn to the Exchequer in 2023. They also make material contributions to the UK through other taxes such as VAT, income tax and NIC. There was also £1.2bn of dividends paid in 2023, which will have secured additional tax revenues.
The issues in AIM have become increasingly obvious and have resulted in a stark reduction in IPOs and money raised as shown below.
Financial impact of budget changes
There was a modicum of relief post the budget that BPR had been retained at the 50% level rather than removed entirely. This should not be interpreted as removing the issue as AIM is still c.10% lower vs the smallcap sector since June, with a loss of market value of c.£7bn. Furthermore, this comes before the impact of the budget is felt through changes in investor allocation and fund flow.
HMRC estimated that there was a tax cost to the Exchequer of £185m from IHT relief from AIM shares (c.£0.1m at 50%), which is materially lower than the original widely-reported estimate from the IFS of £1.1bn, rising to £1.6bn. In our view, the HMRC number is overstated as it does not incorporate the tax offsets and we believe the behavioural change is materially understated as investments will switch to private funds in order to benefit from the £1m exemption.
We estimate that the changes will result in a >£1bn reduction in tax revenue rising to >£2bn. This is predicated on:
- The current level of capital loss (c.£7bn) combined with additional underperformance due to negative fund flows.
- Absence of capital gains.
- Lower employment given the reduction in growth capital.
- Reduction in capital market activity.
- Lost value in LTIPS and options.
We have not included the likely material increase in investment in private assets (ie securing 100% relief) in these numbers given that the scale is hard to judge.
Unintended consequences
We expect the budget changes to result in a surge of funds into private vehicles, particularly given the changes to pension tax. These vehicles generally aim to deliver a consistent return (c.3%) and focus on capital preservation, which provides an added attraction now the tax relief has been reduced. This is highly likely to store up future problems given the lack of liquidity in most of these vehicles, which already have c.£10bn of AuM.
