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Fractional Shares in ISAs: How HMRC is Making a Huge Mistake and Why This Matters

Published on
October 16, 2023

Should everyone be able to invest?

Or should investing be restricted to the wealthy?

This question is at the heart of HMRC’s recent comments that fractional shares are not eligible to be in ISAs (an ISA is an individual savings account that allows UK investors to save or invest their money tax-free).

HMRC believe that a fractional share is not the same as an actual share and thus, any fractional shares held in ISA must be taxed as normal. This could have huge implications for UK investors.

This article will break down the situation and give you our take on why we believe what HMRC are doing is a mistake.

1. What are Fractional Shares?

Firstly, what even is a fractional share?

As you may surmise from the name, fractional shares allow investors to purchase a portion or fraction of a single stock rather than having to buy whole shares.

For example, rather than buying 1 full share of Microsoft at $300 per share, an investor could purchase 0.1 shares of Microsoft for just $30.

2. What’s the Point of Fractional Shares?

A. Increased accessibility

Fractional shares make investing accessible to all.

Let’s go back to the example above. If you wanted to start investing and you only had $100, and if you’re buying full shares only, then you’re restricted to buying stocks that cost less than $100.

Fractional shares allow you to theoretically buy shares in any company. This opens up more opportunities for the investor.

B. Greater diversification

Diversification is when you spread your investments across many different types of stocks to protect you from being overly exposed to one particular area.

For example, if all or most of your stock investments are in aviation and the aviation market crashes (like it did during the pandemic when everyone stopped flying), your entire portfolio will be in trouble.

Fractional shares allow investors with less money to benefit from diversification. It allows investors with just $500 or even $100, to spread their money across multiple shares.

C. Easy dollar-cost averaging

Dollar-cost averaging is when you regularly invest a fixed amount. For example, you could invest $100 every month after you get your paycheck. Fractional shares allow you to easily invest in your current portfolio with low amounts regularly.

Otherwise, you’d have to compromise on which stocks you invested in each month.

3. What has HMRC said about this?

In recent years in the UK, many low-free brokers have launched, such as Freetrade and Trading212, that allow investors to invest in fractional shares with low amounts in an ISA.

However, in a recent meeting with industry and treasury officials, HMRC declared their opposition to this as they don’t believe the current regulations allow for this.

The relevant piece of legislation is The Individual Savings Account Regulations 1998 where regulation 7 sets out the qualifying investments for stocks and shares ISAs.

Part 7 (2) (a) lists shares as a qualifying investment.

HMRC’s position is that a fraction interest in a share is not a share and that the ISA Regulations Act 1998 only refers to whole shares. Therefore “a fraction of a share cannot be held in an ISA.”

4. Why HMRC are Making a Mistake

However, this is wrong given that in practice according to Tax Policy Associates, all shares held in an ISA are fractional interests.

They provide an example for this: let’s say you open an ISA account with a broker. When you buy shares in a company through this broker, you don't literally own identifiable shares registered directly in your name. Instead, the platform pools all its customers' shares together into one big account. You own a fractional beneficial interest in this pool.

To illustrate this, imagine that the broker has a pooled account that contains 900 shares of AstraZeneca. You want to buy 100 shares of AstraZeneca. The broker will purchase these 100 shares for you and add them to the pool which now has 1,000 shares of AstraZeneca in total.

You now have a beneficial ownership of 10% of this pool of shares, i.e. you have a fractional interest.

This means:

  • You still receive 10% of any dividends paid to the platform's account
  • You can still vote on 10% of the shares in the platform's holdings
  • If you sell, the platform doesn't specifically sell "your shares." They just sell any 100 shares from their pooled account, reducing your beneficial interest in that pooled account from 10% to 0%

The process works this way as it’s efficient and scalable for the providers and it’s still safe for investors, as the beneficial interest still resides with them and all shares stay within the custody accounts.

The whole point is to show that all shares in an ISA are fractionalised! Therefore, there’s no reason for HMRC to cause a fuss and try to treat fractional shares differently.

Final words

In conclusion, fractional investing delivers a profoundly positive impact - it makes the markets accessible to all. For students, young professionals and lower-income families, the doors of opportunity swing open. No longer must the financial markets be dominated by the wealthy elite. Equity belongs to all people.

HMRC now stands at a crossroads. They can either obstruct fractional share adoption in ISAs and risk alienating young and lower-income investors. Or embrace it, and unlock a fairer future where anyone can invest and build wealth.

Ahead of the coming Autumn Statement (where the government sets out its plans for the economy), the government has been lobbied to clarify the ISA Regulations to specifically include fractional shares as a qualifying investment.

The choice is clear. Fractional shares democratize capitalism itself. They allow regular people to bootstrap their way to prosperity. Is this not what we strive for?

HMRC should correct their course and clarify once and for all that fractional shares are permitted within ISAs.

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