Now even Isa shelter isn’t safe as the taxman targets ‘sliced’ shares

Investors could be forced to pay tax on some shares held in their Individual Savings Accounts (ISAs) after a bizarre move from HM Revenue & Customs.

The IRS states that so-called “fractional shares,” where investors hold portions of shares rather than whole shares, are not eligible investments for Isas. As a result, it could force investors with fractional shares to pay capital gains tax on any gains when they go to sell.

The move will affect those with smaller portfolios and smaller purses, who often cannot afford a single share in well-known US companies such as Google, Apple and Tesla, where shares cost hundreds of pounds each.

Investing in a fractional share means these investors can own part of a large number of companies, rather than individual shares in just one or two. Their portfolio is then more balanced and less exposed to the fate of just one or two companies.

Tax experts say the move undermines the government’s commitment to opening up investing to everyone, regardless of their budget.

“Offering fractional shares is particularly beneficial to the smaller investor or saver and is in line with Isa’s goal of encouraging investing and saving within the retail market,” said Lisa Laybourn, head of technical policy and regulation at trade organization The Investment and Savings. Alliance (TISA).

“It seems unfair,” adds Katharine Arthur, who runs the private client business at leading accounting firm Haysmacintyre, advising individuals and businesses on tax compliance. “I’m not sure why HMRC is concerned about this when the government is supposed to encourage share ownership and investment in the business sector.”

She says a final decision on sanctions for those with fractional shares in Isas could take “months or more,” leaving investors unsure whether their current portfolios violate the rules. “There’s nothing that puts people off more than uncertainty,” says Arthur, suggesting that some younger people who invest in fractional stocks might stop investing altogether.

A tricky argument

Isa providers that allow their clients to buy fractional shares include Moneybox, Freetrade, Trading 212, and Wombat Invest. Larger platforms such as Hargreaves Lansdown and Interactive Investor do not. However, HMRC has written to providers that current legislation means fractional shares cannot be held in an ISA.

The 1988 Isa regulations say ‘shares’ can be held in an Isa, but HMRC believes this does not refer to share sharing, meaning those holding them are breaking the rules. A spokesman for HMRC says: ‘Fractional shares cannot be held in an Isa. Isa managers must ensure that the investments they offer are eligible for Isa.’

However, he was unable to comment on talks with companies offering the Isa’s because of “strict secrecy laws.” While HMRC is threatening action against companies if they fail to comply, “we cannot comment on timetables,” the spokesperson added.

Freetrade has taken legal advice on the matter and believes that current Isa rules do not prohibit holding fractional shares in an Isa.

“Until this matter is resolved, we will continue to offer fractional shares,” said a spokesman. Investment app Moneybox says: “We would support an update to the legislation to clarify HMRC’s decision, but we see no reason for the position that clients should be prevented from holding fractions of shares in Isas.” Mukid Chowdhury, chief executive of Trading 212, says the company has taken legal advice and believes fractional shares are within the scope of existing Isa regulations.

He says: ‘Trading 212 is in active discussions with HM Treasury to review this situation, particularly as HMRC’s view appears to be at odds with the government’s objectives. We have also tried to engage the Treasury’s Minister of Economic Affairs, Andrew Griffiths MP, on this issue.’

Others, however, believe that HMRC is right to prohibit tax-advantaged investments in fractional shares. Grzegorz Drozdz, a market analyst at investment firm Conotoxica, says they are not defined as securities, but rather as shares in an entity. “This difference may seem subtle, but it matters,” he says.

Part of the problem is believed to stem from the fact that fractional shares can complicate the process if an investor wants to transfer their Isa to another.

Can I get a fine?

Clients holding fractional shares in Isas may be subject to penalties if found to be in violation of Isa Rules.

Arthur van Haysmacintyre says HMRC could in theory fine both individuals and the provider. Clients may have to pay capital gains tax over several years.

The tax authorities can also charge interest on unpaid tax. Some individuals may also have incorrectly failed to file a tax return because their only reason for doing so would be to pay the capital gains tax now due on non-compliant ISAs.

“Over a number of years, the amount adds up for that person and can be expensive,” she says.

“Hopefully HMRC will be open to reducing fines or suspending or not charging them.”

Freetrade says it is committed to ensuring customers don’t lose out if the IRS imposes fines.

“We will stand behind our customers and make sure they are not at a financial disadvantage,” says a spokesman.

Future for fractions?

One way to ensure that fractional shares remain is if the Isa rules are changed. This would be a task for HM Treasury rather than HMRC.

TISA says it is in talks with the government about making simple changes to the law that would be a “simple fix” and cost the government nothing.

Meanwhile, the ambiguity and ongoing talks leave young investors looking to buy some of their favorite stocks in limbo if they want to invest tax-efficiently.