Putting international shares in an Isa

International shares are a great way to diversify your portfolio. But putting them in your Isa is far from simple. Here's what you need to know, and a list of four of the cheapest online brokers.

It's a good idea to get exposure to international shares in your search for income and growth and to diversify your portfolio. But when it comes to putting such shares in an Isa, the rules aren't entirely straightforward and many brokers don't make things easy. Here are the key things to be aware of.

What can you hold?

The regulations say you can hold foreign stocks listed on a "recognised stock exchange" in an Isa. In general, the main exchanges in most major developed markets qualify, as do a number of emerging-market exchanges. Small caps and growth companies often do not.

There's a list of recognised exchanges here. Corporate bonds qualify if they are themselves listed on a recognised stock exchange or issued by a company listed on one.

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However, the fact that an investment would be permitted under HMRC rules doesn't mean every Isa provider will allow you to hold it. Most brokers only trade a limited selection of international markets. And even within these, some may only allow a more restricted range of foreign securities than HMRC's rules permit.

What about foreign funds and ETFs?

For a fund or exchange-traded fund (ETF) to be eligible for an Isa, it needs to be authorised for sale to UK investors. Since relatively few foreign funds will apply for UK authorisation, most non-UK funds will not be eligible.

What's the tax treatment?

Isas will shelter you from UK income and capital gains tax on foreign shares, but don't receive special treatment from tax authorities in other countries. This means that, if the foreign government deducts withholding tax from dividends, you will suffer the same deduction that you would if you held the same share outside an Isa.

However, if you are normally entitled to reclaim some of this withholding tax from the foreign government under a double taxation agreement (DTA) between the UK and the foreign country, you should be able to reclaim this for shares held in an Isa too.

What will it cost?

There is one big catch to holding foreign stocks in an Isa: any tax savings you make can easily be swamped by added costs. That's partly because brokers typically charge higher trading fees for international stocks and higher account fees for Isas than for a regular account, but also because most brokers charge you commission for converting sterling into a foreign currency and back again.

This currency charge can be up to 2% in some cases and is the big hidden cost of international investing it can often be greater than the trading fee itself. For this reason, it's best to avoid converting currencies more than you have to but unfortunately, the regulations only allow cash in sterling within an Isa.

As a result, you will need to convert to and from sterling on every purchase, sale and dividend received. It's easy to see how these additional costs could easily outweigh the tax savings from using an Isa.

The best online brokers for international stocks in an Isa will depend on your trading pattern, but the table below lists four that we calculate to be among the cheapest (our estimated costs are based on one year's Isa allowance only, invested in equal monthly (M), quarterly (Q) or annual (A) amounts).

For other markets, a broker that doesn't offer an Isa wrapper may often work out cheaper Interactive Brokers and Saxo Trader are among the cheapest and most comprehensive around.

The best online brokers for international stocks held in an Isa

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iWebwww.iweb-sharedealing.co.ukBelgium, France, Germany, Italy, Netherlands, UK, USNo Isa fee, £5 per deal, 1.5% foreign-exchange commission (with effect from April)£229/£189/£174
iDealingwww.idealing.comUS, Canada and most of western Europe£20 per year Isa fee, £9.90 per deal, trades via market makers that charge up to 0.5% foreign-exchange commission£195/£116/£86
Sippdealwww.sippdeal.co.ukUS, Canada and most of western EuropeNo Isa fee, £9.95 per deal, trades via market makers that charge up to 0.5% foreign-exchange commission£176/£96/£66
Saxo Modern Wealth Managementwww.modernwealthmanagement.co.ukBelgium, France, Germany, Netherlands, Spain, UK, US£35/year Isa fee, 0.15% per trade (min £9.95), no foreign-exchange commission£154/£75/£52