We see material downside risk for AIM from removing IHT relief. Moreover, our forecasts show a net tax reduction to the Exchequer of £2.6bn, rising to £3.2bn. This is in marked contrast to the £1.1bn increase in tax suggested by the IFS. We do not recognise this number.
CGT rate rises would diminish risk appetite and tax take, with HMRC estimating a tax reduction of >£2bn from raising CGT rates 10%. The best way to increase CGT remittances is to revive the equity market: the OBR estimates each 1% market increase brings in £0.5bn.
Existential – in our view, the future of AIM as a functioning market is at stake. We trust that the Government and Treasury recognise the opportunity to accelerate growth and investment, rather than fatally undermine the market.
AIM underperformance
AIM has underperformed the FTSE Midcap index by 10% and the Smallcap by 17% YTD, with the gap widening significantly since the prospect of material tax changes emerged. There has been no official comment on IHT and CGT, but we understand both are under review.
Key points for government
· Recognise the scale of the potential negative impact on AIM from removing IHT relief and raising CGT.
· Confirm the retention of IHT relief for AIM shares, with a long-term commitment, given the average holding period of >10 years.
· Encourage investment in AIM with a lower rate of CGT than the Main Market/other assets.
· Assess proposals (below) to revitalise the UK’s growth market.
Impact of removing IHT relief
There have been several reports suggesting that removing Business Property Relief (BPR) from AIM shares would be tax enhancing. Notably, the IFS suggested a £1.1bn increase in tax, rising to £1.6bn per annum. We believe these numbers are flawed for numerous reasons, and estimate a material reduction in tax revenue. There are several points to highlight:
· BPR relief on AIM shares was introduced in 1996 to encourage investment in smaller UK companies, to enable them to scale and grow. This has been a highly successful policy, with the value of AIM growing from £80m and 10 companies in 1995 to c.700 and >£70bn of value today. This tax incentive is a cornerstone of the AIM market, and we believe removing it would have material consequences, as discussed in our recent note AIMing higher.
· AIM companies are responsible for close to 800,000 people being employed and contribute £68bn in gross value added (GVA) to GDP.
· The IFS numbers look materially overstated, even if they are only incorporating the tax foregone – we estimate this to be c.£0.4m per annum. We presume that the IFS has not accounted for the material loss of shareholder value, employment income, and impact on the broader ecosystem around AIM companies.
· We see an impact on the AIM market of 20-30% if BPR is removed, crystallising a loss of value £14-21bn to UK shareholders, resulting in a permanent destruction of spending power. Some of this can already be seen from the underperformance over the last few months.
· We expect there would be permanent damage to the AIM market, as funds would move to more liquid assets. It would also damage fundraising through EIS and VCT, given that AIM would no longer provide a healthy background to support growth companies.
· A large number of employees in AIM companies are remunerated through options – many of these would become worthless, resulting in a loss of value for a large number of people working in smaller companies across the country.
Our headline numbers estimating the impact of removing BPR (ie IHT) on AIM shares are shown in Figure 1 below. We only include the direct impact, and not the knock-on effects from the likely permanent reputational damage to UK equity markets, sales of smaller growth companies to overseas companies, entrepreneurs’ desire to start and scale their businesses in the UK, and lower savings reducing spending power.
Figure 1: Change in tax revenue from removing BPR on AIM shares
Source: Peel Hunt estimates
We estimate a net reduction in tax receipts of £2.6bn, rising to £3.2bn in 2026/27. Note that this includes the increase in IHT receipts, as well as the negative impacts on tax revenues.
For those that want to look at the Government numbers, this report shows the total level of BPR to be £1.3bn in 2023/24. This includes both private companies and funds, as well as AIM shares.
The latest detailed data is from 2021/22. This showed that the total amount of estate value relieved in 2020-21 was £3.2bn (ie the gross value that would potentially be subject to 40% IHT), of which £2.55bn was on unquoted shares, and just £0.64bn on other business property, which includes AIM shares. HMRC has the full details, but this data makes us confident that our estimate of c.£0.4bn is in the right ball-park. This report provides further details on IHT, with BPR included in note 5.2.
Given the importance of IHT relief to the AIM market, we consider it essential that the government not only confirm its continuation, but also its long-term retention. Given that the average holding period is > 10 years, we believe long-term visibility is of paramount importance.
Capital gains tax (CGT)
There has also been speculation over an increase in capital gains tax (CGT), which generates c.£15bn per annum, with some suggestions that it should be equalised with income tax. The theory is that ‘unearned income’ should be taxed the same as ‘earned income’. In reality, we see a number of issues with this theory:
· CGT is a voluntary tax, in the sense that you can acquire assets that are exempt from CGT (eg gilts), and you only pay the tax when you choose to liquidate. Furthermore, CGT gets wiped out on death, as you only have to pay IHT. In contrast, income tax has to be paid as it is earned.
· There is no indexation on CGT, so if the gain is similar to the level of inflation over the period, then the investor ends up with a tax bill and a negative real return. In contrast, wages generally rise with inflation.
· Investments are made with income that has already been taxed, which means that they are subject to double taxation.
· CGT is charged on investments where capital is at risk, whereas wages are regular income.
There is an issue when individuals seek to convert income into capital gain in order to reduce their tax bill, but this is fundamentally different to the gains made on personal investments.
As mentioned above, the level of CGT has a direct impact on the behaviour of investors. Make it too high, and there is no point in investing in risk assets or crystallising a gain. As a result, the level of tax generated is a bell curve, depending on the rate charged.
Optimising tax is only one part of the equation. It is also important to recognise the negative impact of pitching the rate too high. Generally, governments are keen to encourage investment in equities for a number of reasons:
· To create a savings culture so people rely less on the state.
· To generate income to enable future consumption.
· To provide funding for companies to invest and scale.
The government can also use CGT to encourage investment in particular areas. For example, gilts being exempt demonstrates that the Government is keen on investors buying Government bonds. Similarly, equities have a different rate of CGT (20%) to property (24%). When considering changes to the CGT regime, we recommend that the Government keeps in mind some core principles.
· Investing in equities helps to drive economic growth and tax revenue, and increase savings.
· The UK equity market has been starved of capital as investing has globalised and pension funds have de-risked.
· Smaller companies rely more on investment from domestic investors than larger companies, with individual investors owning 24% of AIM, vs 8% for the FTSE 100.
The last point is particularly important. If CGT is raised to a level that is perceived to be penal, then individual investors may further steer away from higher-risk investments (eg AIM shares) towards lower-risk (eg gilts, bonds, or passive funds).
A further issue is that high rates of CGT may encourage individuals to invest in funds, and particularly passive funds, as there is a clear tax advantage. Investors in funds only pay CGT when they sell the fund, whereas investors in individual shares crystallize the gain when they sell their holding. Effectively, this defers the creation of a gain, and hence the payment of CGT. Investors in passive funds tend to be long-term holders, as the very essence of the investment is avoiding the need to trade, thereby deferring the likely payment of CGT. Encouraging investors to move into passive funds has positive aspects, given their low cost and performance. However, there are material side effects:
· Passive funds seek to replicate the performance of an index, which means that they focus on larger, more-liquid shares.
· The trend to global passive funds results in outperformance of the largest companies in the world, with smaller companies seeing limited attention.
· Passive funds largely bypass AIM.
· Passive funds do not support IPOs, and are effectively ‘absentee landlords’.
In 2022/23, the amount of tax collected from CGT was £14.4bn, from 369,000 people. There is no full breakdown on the composition of CGT, but HMRC has stated that property represented £1.6bn in 2023/24. In 2021/22, 37% of the gains were in listed companies, and 63% in unlisted. Extrapolating these numbers means that the level of CGT paid on listed shares is c.£5bn. The median average holding period for shares is 1-2 years, which shows the importance of the level of CGT on the holding period, and the potential for a material rise in CGT to impact the level of tax generated.
HMRC has produced a detailed report, as has the OBR, which estimates that CGT will raise £15.2bn in 2024/25. The OBR also shows that a 1% increase in equity prices generates an extra £0.5bn in CGT – this indicates a large correlation between higher prices and tax take, and demonstrates very clearly why stimulating the UK equity market has a direct impact on Government revenues. Of course, this works in reverse as well, which is why removing IHT relief from AIM shares would have a material direct negative impact on tax take.
As discussed above, CGT is a voluntary tax, and changes to the rate of CGT can have material impacts. This is recognised by HMRC, which calculated the expected impact from changes in rates in its June 2024 report. This suggests that a small increase can raise tax take, but larger increases materially reduce the level of tax collected.
Figure 2: Higher increases reduce tax-take
Source: HMRC
This is recognised in the IFS October 2024 report, which states that higher rates of CGT would incentivise people to leave the UK. This is particularly apposite, given that the majority (66%) of CGT is paid by people with gains of over £1m. This is paid by a relatively small number of people (c.12,000). For this reason, a number of commentators have suggested an exit tax. The IFS also recognises that higher rates would impact how much people save and invest, and the duration of savings.
HMRC has also provided a helpful guide to the timings of tax changes (albeit not all are included) and the levels of gains and tax generated.
Figure 3: Amount of gains and tax paid
Source: HMRC
This shows a rising gap between the level of gain and the amount of tax paid, which reflects the reduction in tax rate in 2016/17. It might be tempting to think that more of this gain could be captured, but of course the level of gain would reduce materially if the tax rate was increased.
How to accelerate AIM
We recently produced a report highlighting the importance of AIM for business creation, scale-up funding, job creation and economic growth in the UK.
AIM has been impacted by the general malaise in UK equity capital markets, which is particularly manifest in smaller companies. We see changes to IHT relief and CGT as existential to the ongoing success of the market.
In contrast, we believe the Government could enact changes to turbocharge the market and ensure that AIM is the pre-eminent growth market for smaller companies globally. The headlines recommendations are below, and more details can be found in the report.
· Expand the remit of the British Business Bank to include equities
· Increase funding for the Business Growth Fund
· Utilise the NatWest stake to develop a listed National Wealth Fund
· Pension reform to ensure minimum level of investment in UK assets
· Mandate pensions to invest a proportion of funds in AIM
· Develop cornerstone financing for IPOs
· ISAs and SIPPS to have minimum level of UK ownership
· Support tax incentives to drive growth
· Address the cost of being listed
· Encourage alignment of NEDs with shareholders through equity
