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AIM Less Tax Break

Richard Teather - Thu 18 Oct, 2007

AIM shares are treated as unlisted. So provided the company qualifies as trading, your shareholding will be a business asset for taper relief purposes. This is obviously a big advantage. But taper relief is being abolished from April 2008. Instead there will be a flat rate of 18% for all capital gains. There will no longer be any capital gains tax advantage to AIM shares, so AIM investments will be less attractive. This could have a major impact on your AIM investments. Whats more, if many people are investing in AIM solely because of the tax advantages, then there could be a more general collapse.

Might Alistair Darling’s Pre-Budget report have a wider impact on your investments? Today we’ll look at AIM shares.

Firstly, capital gains tax. Oddly, AIM shares are treated as unlisted. So provided the company qualifies as “trading”, your shareholding will be a “business asset” for taper relief purposes. This is obviously a big advantage. Unless your annual gains are under the threshold (currently £9,200), you could be paying 40% tax on gains on stock market investments but perhaps only 10% on an AIM investment.

But taper relief is being abolished from April 2008. Instead there will be a flat rate of 18% for all capital gains. There will no longer be any capital gains tax advantage to AIM shares, so AIM investments will be less attractive.

There are also inheritance tax advantages to AIM shares. Shares in an AIM-listed trading company will generally be fully exempt from inheritance tax. This will not change under the pre-Budget report, but the advantage will be diluted because the transferable allowance between husband and wife is likely to mean that fewer people will be over the threshold, so fewer will be seeking to avoid the tax.

Of course the inheritance tax exemption will still be valuable to people who are above the threshold, but the tax advantages of AIM have clearly been reduced, making it less attractive to investors.

The problem is that we don’t know the extent to which the AIM market is propped up by these tax advantages rather than its inherent value. Evidence from studies around the world shows that any tax advantages for investments translate straight into higher values, so if you give a 10% tax advantage to an asset the value of that asset goes up by 10%. Conversely, if you take away the tax advantage, the value goes down.

This could have a major impact on your AIM investments, and although the extra tax is only 8% the drop in share values could be higher. Under the current tax system (and making some broad assumptions about your tax situation), you could keep 90% of the capital gain on your AIM shares but only 60% from shares listed on the full market. That suggests that one third of the value in AIM shares comes from the tax advantage that is being taken away.

What’s more, if many people are investing in AIM solely because of the tax advantages, then there could be a more general collapse. That probably won’t happen, because the inheritance tax advantages should still underpin the market, but the risk of a significant tax-driven downturn across the AIM market in general seems high.

Regards,

Richard Teather

For The Daily Reckoning UK

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