The tide of companies flowing from Aim to the Official List is set to strengthen. Simon Keane looks at the implications and opportunities of this migration for investors

What’s in a market? You may ask. Does it make any difference if a company is traded on Aim or on the London Stock Exchange’s (LSE) main board? It makes a big difference, and any investor in Aim would do well to get to grips with why, given the growing number of companies moving up. Last year, three Aim companies moved to the main market. This year, Shares research puts this number at at least 13. And the recent defection of ferro-chrome producer International Ferro Metals (IFL), a £530 million one-time mega cap of Aim, indicates the recent market turmoil has not changed things in this respect.

In many company meetings lately the conversation has eventually turned to Aim and the main board. With the seed planted in their heads by the corporate advisers, directors are visibly toying with the idea of moving up. The reasoning varies – ‘fund managers can only put a limited percentage in Aim companies’, ‘I’ll get a higher profile on Aim’, while others are clearly worried about the reputation problem. Aim has had some high-profile company disasters and being described last year as a casino by a US Securities and Exchange Commission (SEC) commissioner didn’t help its image, although the LSE has since tightened up rules.

But whatever the reasons are, the exodus is happening and the sooner you get to terms with the implications the better, since what is a trickle is tipped to turn into a steady tide. Head of small companies at broker Collins Stewart, Paul Compton, says 30 companies moving next year is not an unreasonable thought. He says the potential for inclusion in the FTSE All Share index – and the perception that this will help the share price – is driving decision making. Indeed, once on the main market, a company with a market cap of more than £97 million should have no problem securing its place. That puts any company with a market cap of more than £100 million in the frame to move.

If this is the case you may expect every constituent of the FTSE Aim All Share, the market’s leading index of shares, to have at least wondered about switching. And, given that tracker funds own around 10% of the FTSE All Share, the logic is clear. Most trackers in the UK are based around the All Share and they set computers to do their buying once a company enters the index. But whether a private investor can make money on this is, at least on present evidence, questionable.

Caveat investor

Visit any bulletin board for investors, however, type in ‘tracker’ plus the name of an Aim share going to the main market, and you’ll find punters who have bought this strategy. By no means has buying shares anticipating they will go into the All Share been without merit. Study the way share prices of FTSE Fledging stocks have behaved around the time FTSE Group (the index compiler) announces its decisions on index inclusion and the buying opportunity is clear. But in the case of Aim companies moving up to the main market, while there is only a small sample to go on, the numbers don’t yet stack up, and current fragile markets mean any impact of institutional buying may well be wiped out.

Investors would be better advised trying to understand the implications of a move to the main market for their tax position. Many companies moving to the main market, by virtue of being bigger and more successful, have rocketed in the past few years, and investors are now sitting on hefty capital gains.

Those who know how to play the tax system properly will see the potential of benefiting from the mixed-asset rule. But first let’s go back to why the idea of Aim movers benefiting from being included in the FTSE All Share just does not stand up. Early movers IP Group (IPO), Connaught (CNT) and Accident Exchange (ACE) did experience a spike around the time of their inclusion in the FTSE All Share. They rose 12%, 40% and 9% respectively. But since then the experience has been mixed. At the time of going to press FTSE Group was holding its September review (12 September) and we expect New Star Asset Management (NSAM), Imperial Energy (IEC), Vectura (VEC) and NCC (NCC) to have had entry confirmed by the time this magazine hits the streets.

So how have their prices done in advance of this announcement? Not very well, in a nutshell. Imperial has fallen 6% and New Star has dipped 1%, meaning any gains investors would have made on NCC, up 11%, will have been neutralised. Note here we looked at the share price performance up to 13 July, before the market selloff, so that can’t be blamed. But the selloff in itself should make investors wary of deploying a FTSE-inclusion strategy in such shaky markets.

Vectura is another company due to have gained entry to the All Share at yesterday’s review. We didn’t include it in our analysis since it only announced it was going to the Official List on 13 July, so any impact of institutional buying was going to be drowned out by the ensuing correction. Interestingly, it has outperformed the overall market by 7% in the past month, but it’s no use to investors given the absolute fall in the share price. At present, you’re probably better off working out how your company’s move to the main market impacts your tax position.

The mixed-asset rule

As we all know, Aim companies get much more favourable treatment than those listed on the main board. One of the main benefits is a 10% rate on capital gains after two years compared with the usual 40% (This benefit is called enhanced taper relief and only kicks in for shares deemed unquoted by HM Revenue & Customs: a classification into which Aim shares fall along with the shares of private companies). Taper relief (TR) does apply to shares on the Official List but investors get nothing after two years and have to hold for a decade to get the full effect, by which time they will still be giving the government 24%. While this is widely known, few realise they still pay only 10% on some gains, even after the company has moved to the main market, which brings down the average tax bill.

A wrinkle in the tax rules means the shares of companies that have spent some time listed on Aim and then the main market are treated as mixed assets. This will become important given that Aim’s bigger and more successful companies have been moving up to the main market. Here an average tax bill somewhere between 10% and 40% can mean saving many thousands of pounds on the full 40%. Barring the reserves scare in March, successful companies that have moved include Russian oil explorer Imperial Energy, up 114% since August 2005, and social housing group Connaught, up 124% over the same period.

Neil Pamplin, client service director at accountants Grant Thornton, says: ‘Investors should be aware of the company’s history in computing their capital gains at the end of the year. There may be valuable hidden pitfalls – or valuable benefits – in the stock’s history.’ If you held IP, Accident Exchange or Connaught and sold them prior to the 31 March tax year this is worth considering for you current tax return, which is due on 30 September. But given most of the recent Aim to main moves have happened since April the mixed asset rule will become a more significant consideration this tax year. We illustrate how you could make massive savings on your tax bill if you play the system correctly.

Dual-listing problems

Taking the examples of Connaught and Imperial again let’s assume you sold on 21 August having made a £5,000 investment in each of the previous two years (see illustration). You would have made gains of £6,214 and £5,681 respectively. Connaught moved to the main market on 6 November 2006 while Imperial stepped up on 9 May 2007. If you apply the mixed asset rule you’ll save £1,144 and £1,459 respectively. But while the savings may be significant, they can’t be applied to First Quantum Minerals (FQM), Oilexco (OIL) and Yamana Gold (YAU). These companies, all incorporated in Canada, are dual-listed on the Toronto Stock Exchange and as such will have been ineligible for the 10% rate on Aim. The issue of dual listing brings us back to why buying Aim movers anticipating that they enter the FTSE All Share is of limited benefit.

Purchasing these dual-listed companies for the promotion boost alone would be inadvisable. Under FTSE rules, companies with multiple listings usually only qualify for the All Share if the London-traded shares are more freely traded than the shares on the overseas market. It is unclear whether First Quantum, Oilexco or Yamana are more liquid in London or in Toronto, and investors would need to get an inside edge on FTSE’s decision-making process (where a fair amount of discretion can be exercised) to know where its committee goes on these.

The flow of companies moving from Aim to the main market is growing. The junior market will have problems holding on to some of its bigger constituents. As anything with a market capitalisation of more than £100 million is a potential mover, almost all the companies in the market’s index of leading shares, the FTSE Aim 100, is in the frame. Rumours will keep circulating of company X or Y moving, some say the replacement of the finance director is a sure-fire sign the company is gearing up for the stricter reporting requirements of the Official List. But rather than being seen as a opportunity to make more money through index-inclusion these hints should start you thinking about how you can save more of what you have already made from the tax man.

FTSE All Share inclusion drives up fledgling share prices

One of the key implications of a company moving to the main market is the possibility of inclusion in the FTSE All Share index. Institutional tracker funds, that automatically buy anything that goes into the index, own about 10% of the FTSE All Share, and it is fair to assume that inclusion is positive. Indeed, over recent years there has been a sharp appreciation in FTSE Fledgling promotion candidates before – and one month after – the FTSE Group (the index compiler) annual review in early December, when entrants are confirmed.

These annual reviews are the best chance for a Fledgling stock to get into the All Share, since entry standards are tougher at the other quarterly reviews in March, June and September.

Given the size of tracker funds, they have to stagger buying, and it is understood they do this in the period up to two months before the review date and in the one month after the review. In 2005, during that three-month period around the review date, eight of the nine promoted Fledgling companies rose, seven went up by more than 10% and the average gain across all nine was 24%, these across-the-board gains were replicated in 2006.

Listing explained

The main board and Aim are the two key markets for trading shares in the UK and both are operated by the London Stock Exchange.

But the rules companies have to follow to get their shares ‘admitted to trading’ on these markets are very different.

To get admitted to the main board a company first has to get itself on the Official List of the UK Listing Authority (UKLA), which, as an arm of the Financial Services Authority, is the market’s policeman.

In comparison, Aim is known as an ‘exchange-regulated’ market, where the LSE is itself in charge of the oversight and setting the admission rules. The LSE does not have an equivalent to the UKLA’s Official List so technically it’s incorrect to describe an Aim company as ‘listed.’

The UKLA’s rulebook for companies is much more prescriptive than the LSE’s rules and the latter farms out most of the oversight function to the companies’ corporate advisers or nomads.

An exchange-regulated market is generally easier for companies to get on to, although, as some high-profile failures have shown, it may not necessarily be so good for the investor. The LSE has recently rewritten the rulebook for nomads to try to restore confidence.

FTSE All Share: is inclusion good for Aim-to-Main movers?

When a new company moves from Aim to the main market it is treated like any other new float. At the point of joining the main market the company, unless it is a mega cap, remains outside all the indices.

After that, however, so long as it has been on the market for 20 trading days prior to the next review date (always on the first Wednesday after the first Friday in the review month) companies with a set market capitalisation (currently over £97.2 million) have a good shot of getting into the All Share, those below that slip into the Fledgling index.

In the past two years three former Aim companies have gained entry to the FTSE All Share, those being IP Group, Accident Exchange and Connaught. At the time of going to press FTSE was holding its September review (12 September) and we expect New Star Asset Management (with a market cap of £920 million it will go into the FTSE 250 segment of the All Share) Imperial Energy, Vectura and NCC to have had entry confirmed. So can the same share price spike be seen with these companies?

As yet the evidence looks inconclusive. For the companies that have already gained entry to the All Share we looked at the share price movement between the date they announced a firm day for moving to the main market to the one month after FTSE announced their inclusion. IP Group rose 12%, Connaught was up 40% and Accident Exchange gained 9%.

That looks good but since then the pattern has broken down. Between announcing a firm date and 13 July (before the summer selloff) Imperial has fallen 6% and New Star dipped 1%, only NCC rose, by 11%. But even if there was a trend, as long as fragile market conditions remain, you risk any gains from tracker buying pressure, being wiped out as sentiment turns south.

Aim and Main Market: differing tax treatment

The government exempts Aim from the usual tax rates that apply to holders of shares listed on the London Stock Exchange or ‘main board.’ HM Revenue & Customs (HMRC) has been instructed to turn a blind eye to Aim and treat shares listed on it in the same bracket as unquoted shares in a private company, where capital gains tax is much lower. Unlike the main board HMRC does not classify Aim as a recognised stock exchange, meaning that securities listed on it are classified as unquoted.

In turn, unquoted shares qualify as business assets and for enhanced TR from capital gain tax up to a maximum of 75% after two years, in effect reducing the tax rate from 40% to 10%. TR is also available for shares listed on the main board but such non-business assets only attract a maximum relief of 40%, and you have to have held the shares for ten years to achieve this, by which time your effective rate will still only have fallen from 40% to 24%.

There are a couple of wrinkles in HMRC’s rules, meaning not all Aim shares qualify for enhanced TR. The unquoted status is lost if the company has a dual listing on another stock exchange recognised by HMRC. In such a case the shares won’t be classified as a business asset and won’t attract enhanced TR from capital gains tax.

There is a further test whereby the business activity is studied. The shares of companies where the business is a non-trading activity (those investing in shares or land) are not classified as a business asset so also fail to qualify. However, and this is where the rules are grey, companies with another activity alongside the non-trading business may still qualify.

Neil Pamplin, client service director at accountants Grant Thornton says a company is unlikely to qualify as a business asset if its ‘substantially’ engaged in a non-trading activity, meaning more than 20% of either the assets, turnover or earnings. However, there remains confusion about which metric this rule is applied to, adds Pamplin.

Filling out your tax return for a mixed asset

You’ll need to let HMRC know in the capital gains section of the tax return when you have a mixed asset. (This part does not come as standard with your return and you’ll either have to ask for a form in the post or download it at www.hmrc.gov.uk/Forms/SA108.pdf). You add the name of the share on page two together with the dates you held it and the disposal proceeds in the section titled ‘Gains on assets which are partly business and partly non-business.’ After this you’ll need to provide further details on pages three and eight.

Grant Thornton has filled out these parts of the form assuming an example where the proceeds from a sale are £110,000, with the shares bought at a cost of £10,000.

In this example the shares have been held for two-and-a-half years, during which time they were listed a year-and-a-half on Aim and one year on the main market. This means, of the £100,000 capital gain, £60,000 is taxed at 10% while £40,000 is taxed at 40%.

However, to arrive at your final taxable gain figure, HMRC taxes a quarter of the £60,000 portion, or £15,000, at 40% (which works out at £6,000 – the same as 10% of £60,000) and adds it to the £40,000 also to be taxed at 40% (see example of how page three should be completed). In this case, the taxable gain, therefore, is £55,000, or £46,200 after taking off the £8,800 exempt allowance.

The form does not ask for further details on how you arrived at your calculations but Grant Thornton says you may wish to put your workings down in the additional information section on page seven. The accountant advises its own clients to give further details for particularly big disposals.