HMRC is trying to tax your ISA?!

  • 4 min read
  • 19 Oct 2023
HMRC tax ISA fractional shares

HMRC had a meeting with the Treasury last week. They discussed fractional shares: that they do not belong in Individual Savings Accounts (ISAs) because they don’t meet ISA regulations. This means, potentially, that they should be taxed. 

This is a big deal. Why? ISAs are meant to be tax-free! So let’s figure out what the heck is happening and leave the panic at the door (or better yet, at the disco) because it’s a lot to digest and there’s lots of jargon.

What’s an ISA?

An Individual Savings Account (ISA) is a type of savings account where you can save £20,000 a year, tax-free. This means you don’t have to pay tax on any profits you make from it.

Types of ISAs

  • Cash ISA
  • Stocks and Shares ISA
  • Innovative Finance ISA
  • Lifetime ISA
  • Help to Buy ISA (closed to new applicants)
  • Junior ISA

In this blog, we’re specifically talking about Stocks and Shares ISAs. 

What happened with HMRC, ISAs and tax?

HMRC’s view on fractional shares in S&S ISAs has been the talk of the town over the last few months – but not in a good way. Considering Jeremy Hunt plans to simplify ISAs, which will be announced at the Autumn Budget that’s creeping up, many expect a clarification.

All in all, things look cloudy at best. The Financial Times reported that HMRC had a meeting with “industry figures and Treasury officials” where they doubled down on their opinion that tax-free ISA accounts shouldn’t hold fractional shares. It’s quite a confusing subject in general and you need a lot of existing tax/ISA/shares knowledge for it to make sense.

What’s a share?

A share is a piece of a company. They’re also sometimes called stocks. If you own a share, you’re a shareholder. You can get shares by:

  • Starting your own LTD
  • Receiving shares from the company you work for
  • Buying them through a broker or investment app

What are fractional shares?

A fractional share is just a fraction of a share. In other words, it means an amount of a share that doesn’t add up to a whole share.

 Many platforms don’t allow investors to buy fractional shares. Newer platforms aimed at young investors, like Moneybox, Freetrade, Trading212 and InvestEngine do.

In terms of investing

If someone wants to buy a share of Amazon but can’t invest too much all at once, they can buy portions of it. If you buy half an Amazon share every month from January and end up with 6 Amazon shares at the end of the year in December.

Why do people buy fractional shares?

  • It’s more affordable
    • It gives smaller, younger investors the opportunity to start building for their financial future
  • To diversify your portfolio
    • Some investors prefer to keep their portfolios diverse and balanced to avoid risk

Being able to have access to fractional shares allows you to build wealth over time and diversify your investments within your own financial means.

Why are fractional shares controversial to have in your tax-free ISA?

Interestingly enough, this issue was actually raised earlier this year, when HMRC raised concerns over The Individual Savings Account Regulations 1998. It was brought to the public’s attention in July 2023. 

The issue: 

Investment apps allow you to buy fractional shares but technically you don’t own them. You only have a right to a fraction. It’s actually called a contract for difference (CFD).

A CFD is:

  • A derivative (so you don’t own it)
  • The agreement between you and your financial broker (like Moneybox, etc.)
  • Based on the change in the share’s price
  • Usually done over a short period of time

HMRC is arguing that according to 30-year-old ISA regulations, derivatives can’t be part of tax-free ISA offerings.

This Is Money reports that an HMRC spokesperson said “fractional shares cannot be held in an ISA. ISA managers must make sure the investments they offer are ISA eligible”.

Why were fractional shares allowed to be offered in the first place?

Good question. Although the investment platforms that offer fractional shares in their ISAs are regulated by the Financial Conduct Authority, no issues were raised.

ISA regulations do not specifically allow or disallow fractional shares. If HMRC interprets the legislation differently than the brokers did, it begs the question: shouldn’t HMRC or the FCA have let the brokers know there’s a grey area in some of their offerings and refuse to allow them to offer fractional shares in their ISAs?

Will I have to pay tax on my ISA?

Hopefully not. Thanks to HMRC’s ambiguous statements, no one is quite sure what they’re thinking and how they expect to move forward. 

There are a few options on how they could proceed, but without any confirmation, it’s speculative:

  • Your broker will have to pay the tax to HMRC
  • The shares from your ISA will be moved to a General Investment Account (GIA) and you’ll have to pay Capital Gains Tax when you sell (on profit more than the £3,000 CGT allowance)
  • You’ll have to pay tax on dividends you receive from fractional shares
  • Nothing happens and fractional shares remain allowable in ISAs
  • You don’t have to pay tax but fractional shares are no longer allowed in ISAs

HMRC can either ban fractional shares from being offered in ISAs or leave them – it’s a waiting game until it isn’t. 

If it’s eventually decided that you do need to pay tax, you’ll need to do it by filing a Self Assessment tax return. However, there’s no need to worry just yet. More than likely, if there is tax to be paid, HMRC will require the ISA managers to pay it.

The Autumn Budget as a beacon of light

Limiting the investing opportunities of people trying to better their future can be unpopular – especially when it affects the smaller and younger investors most. 

Hunt is due to address this in the Autumn Budget as part of his plan to make investing more accessible in the UK. Let’s hope HMRC are also on the same page. We’ll know more on 22nd November, but until then, we’ll keep you updated on any changes!

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