A raid on inheritance tax relief could undermine confidence among investors in the stock market and trigger a sell-off on the junior exchange, the Chancellor has been warned.

Shares on the Alternative Investment Market (Aim) currently enjoy a tax break which exempts them from inheritance tax if they have been held for at least two years. 

The Chancellor Rachel Reeves is looking to scrap the relief in a move which could raise around £1.6bn a year, according to the Institute for Fiscal Studies.

However, the City has warned that it would remove a key incentive to invest in AIM stocks and gut the market of some £6bn managed in specialist inheritance tax vehicles.

Peel Hunt, the investment bank says that scrapping the tax break could prompt an immediate 20-30% fall in the value of shares across AIM.

Julia Hoggett, head of the London Stock Exchange sounded the alarm over the plans last month and warned they could pose a potentially existential threat to AIM.

In a letter to the City minister, Tulip Siddiq, she said scrapping the relief “would remove a core source of capital” and bring the market’s “viability into question”, Sky News reported.

At its peak in 2007, Aim boasted 1,694 companies. That number had slumped to just over 700 at the end of August this year. More than 80 companies have left  Aim in the past 15 months. 

The ecosystem for smaller listed companies is now under threat, according to New Financial, the City think tank and lobbying company.

Like the main market, AIM has suffered from a dearth of companies floating over the past two years. Just £88.6m was raised through IPOs on the junior market in the year to September, just 1% of the £8.8bn raised during the market’s peak year of 2006/07.

Marcus Stuttard, who has run Aim for the past 15 years, denies that the operating performance of Aim-quoted companies is the problem.

While sharing concerns about the inheritance tax threat, he says there are reasons to be positive.

“Over the last five years, 53%t of all capital raised across all of Europe’s growth markets has been raised on Aim,” he told The Times, adding that Aim companies contribute £68 billion to UK gross domestic product and help sustain 778,000 jobs.