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

Investors could be forced to pay tax on some shares sheltered in their Individual Savings Accounts (Isas) after a bizarre intervention by HM Revenue & Customs.

The taxman claims that so-called ‘fractional shares’ whereby investors hold slices of shares rather than full ones, are not eligible investments for Isas. As a result, it could force investors with fractional shares to pay capital gains tax on any profits when they come to sell.

The move will hit those with smaller portfolios and shallower pockets, who are often unable to afford single shares 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 a slice of numerous companies, rather than single shares in just one or two. Their portfolio is then more balanced and less exposed to the fortunes of just one or two companies.

Tax experts say that the move undermines the Government’s commitment to opening up investing to everyone – no matter their budget.

A slice of the pie: Investing in fractional share means investors can own a slice of numerous companies, rather than single shares in just one or two

‘Offering fractional shares is especially beneficial to the smaller investor or saver and it fits with the Isa objective to encourage investing and saving within the retail market,’ says Lisa Laybourn, head of technical policy and regulation at trade body The Investment and Savings Alliance (TISA).

‘It seems unfair,’ adds Katharine Arthur, who runs the private client business at top accountancy firm Haysmacintyre, and advises individuals and businesses on tax compliance. ‘I’m not sure why HMRC is worried about this when the Government is supposed to be encouraging share ownership and investment in business.’

She says a final decision on penalties for those with fractional shares in Isas could take ‘months or longer’, leaving investors uncertain as to whether their current portfolios are in breach of the rules. ‘There’s nothing that puts people off more than uncertainty,’ Arthur says, suggesting that some younger people who invest in fractional shares might stop investing altogether.

A fractious argument

Isa providers that allow their customers 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 stating that current legislation means that fractional shares cannot be held in an Isa.

The 1988 Isa regulations say that ‘shares’ can be held in an Isa, but HMRC believes this does not refer to parts of shares, meaning those who hold them breach the rules. A spokesman for HMRC says: ‘Fractional shares cannot be held in an Isa. Isa managers must make sure the investments they offer are Isa eligible.’

However, he was unable to comment on discussions with companies that offer the Isas due to ‘strict confidentiality laws’. While HMRC is threatening action against companies if they do not comply with regulations, ‘we are not able to comment on timeframes’, the spokesman adds.

Freetrade sought legal advice on the issue and believes the current Isa rules do not prohibit fractional shares from being held in an Isa.

‘We will continue to offer fractional shares until this matter is resolved,’ says a spokesman. Investment app Moneybox says: ‘We would support an update of the legislation to give clarity to HMRC’s decision but we do not see any rationale for the position that customers should be prevented from holding fractions of shares in Isas.’ Mukid Chowdhury, chief executive of Trading 212, says the company had taken legal advice and believes fractional shares are well within the remit of existing Isa regulations.

He says: ‘Trading 212 is actively engaging with HM Treasury to review this situation, especially given HMRC’s view seems contrary to the Government’s objectives. We have also sought to engage the Economic Secretary to the Treasury, Andrew Griffiths MP, on the matter.’

However, others believe HMRC is right to prohibit tax-efficient investment in fractional shares. Grzegorz Drozdz, market analyst at investment company Conotoxia, says they are not defined as securities but rather as shares of equity interest in an entity. ‘This difference may seem subtle, but it matters,’ he says.

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

Could I be fined?

Customers who hold fractional shares in Isas may be penalised if it is found they are in breach of the Isa rules.

Arthur, at Haysmacintyre, says that in theory, HMRC could fine individuals as well as the provider. Customers may have capital gains tax to pay stretching back for several years.

The taxman can also charge interest on unpaid tax. Some individuals may also have wrongly not submitted tax returns, because their only reason to do so would be to pay the capital gains tax now due on uncompliant Isas.

‘Over a number of years, the amount adds up for that individual, and might be costly,’ she says.

‘Hopefully, HMRC would be open to reducing penalties or suspending them or not charging them.’

Freetrade says it is committed to making sure customers do not lose out if the taxman charges penalties.

‘We will stand behind our customers and ensure that they are at no financial disadvantage,’ a spokesman says.

Future for fractionals?

One way of ensuring fractional shares continue is if Isa rules are amended. This would be a job for HM Treasury, rather than HMRC.

TISA says it is engaging with the Government over making simple legislative changes that would be a ‘straightforward solution’ and would not cost the Government anything.

In the meantime, the lack of clarity and ongoing talks leave young investors who want to buy a slice of their favourite stocks in limbo if they want to invest tax efficiently.