Fractional shares: what are they and why HMRC is worried?

HMRC is becoming more concerned about the use of fractional shares on investment apps and platforms such as Freetrade, Trading212, InvestEngine and eToro, which have launched in recent years to appeal to younger and more tech-savvy investors. They let users research and build a portfolio of shares and exchange traded funds (ETFs) either in a general investment account or in stocks and shares Isa from their smartphone.

The apps also offer fractional shares, letting investors buy a portion of a stock rather than the full amount and hold it in an Isa from just £1.

This helps investors build portfolios of their favourite companies and can be cheaper than traditional DIY investment platforms.

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Fractional shares are also regularly promoted by unregulated financial influencers on social media platforms such as Instagram and TikTok.

But the taxman has his eyes on this area of the market with HMRC recently warning fractional shares are not covered by Isa regulations.

An update from HMRC this week said a fraction of a share is not a share and therefore cannot be held in an Isa.

It highlights that the Isa Regulations only refer to whole shares and not parts or derivatives. 

“A fraction of a share does not give the investor the same legal rights as a whole share does,” says HMRC.

“Fractional shares could only qualify for inclusion if the Isa Regulations were amended to allow them. Where fractional shares are an underlying investment in a collective investment scheme or fund, for example an exchange traded fund, they are not subject to the same restrictions.”

Any Isa providers who allow fractional shares to be purchased or held within their Isa have been told to get in touch with HMRC.

This means investors could lose the tax-free status of fractional shares, and end up having to sell their investments and pay tax on any capital gains above the allowance.

Investing apps are hoping for clarity on the Isa status of fractional shares from HMRC and the Treasury in next month’s autumn statement, but how concerned should investors be?

The benefits of fractional shares?

Fractional shares let investors buy part of a stock rather than the full amount.

They have become popular in the US where share prices are particularly high and brokers argue that it lowers the barriers to entry for retail investors.

This may appeal to younger or more cautious investors building a portfolio.

Dan Moczulski, UK managing director of eToro, says fractional shares allow people to get the exact exposure that they want to a certain stock.

It lets users purchase fractional shares in a general investment account but not in an Isa.

“If someone wants to invest $500 in Apple, for example, they can do so without having to calculate the number of shares this sum of money can buy them,” he says.

“For example, at the moment, with Apple being priced around $180, somebody who wants to allocate $500 is forced either to buy $360 worth of shares or $540.

“Fractional shares also lower the bar to entry for retail investors, helping those who have less money to invest achieve diversification. For example, in the past, anyone wanting to buy shares in Warren Buffett’s Berkshire Hathaway b shares would not be able to do so if they weren’t willing to stump up the $343 needed for just one share. On eToro, you can start at $10.”

Tax risks

HMRC doesn’t have an issue with fractional shares as a concept, but the Financial Times reports that it has told investment platforms and the Treasury that they are not eligible for inclusion in Isas.

This is one reason why eToro says it doesn’t offer fractional shares as part of its Isa. Instead, it has a partnership with robo-wealth manager Moneyfarm.

But other providers such as FreeTrade, Trading212 and InvestEngine have let investors build Isa portfolios with fractional shares.

An HMRC clampdown may not hit all investing app users though.

Trading212 lets users invest in fractional shares across UK and US stocks, InvestEngine investors can use this strategy with ETFs but Freetrade only offers it on US shares. This means investors on Freetrade who solely back UK stocks will only own full shares.

Not all app investors will hold their fractional shares in an Isa either.

Freetrade, which launched in 2018 and added US-listed fractional shares in 2020 says of its 650,000 UK users, just 80,000 have Isa accounts.

Of these, fewer than 50% of those accounts hold at least one fraction of a share.

Investing apps such as Freetrade, InvestEngine and Trading212 have said they disagree with HMRC’s approach and are calling for clarity.

Users are still able to open Isas and add fractional shares on these investing apps in the meantime.

“We’re deeply disappointed with HMRC’s position which appears to be based on a misunderstanding of how brokers like us offer fractional shares,” says Adam Dodds, chief executive of Freetrade.

“Our fractional shares give retail customers ownership of a portion of an actual company share. They are not a derivative contract. The protections and benefits for retail investors are effectively the same as for whole shares.”

He said Chancellor Jeremy Hunt’s autumn statement provides the “perfect opportunity” to clarify the rules.

“Any change should be made with retroactive effect to put this matter to rest,” he adds.

“It would represent a huge step forward for the government which has expressed its intention to champion the interests of retail investors.”

HMRC is standing by its position for now but ISA account holders may not need to worry as it is the provider who is liable for any tax owed.

The Isa manager would need to sell or remove the ineligible investments and the proceeds can then usually remain within the Isa and be used to buy eligible investments. Alternatively, the investor may retain the fractions outside the tax-free wrapper.

“Our long-standing view is that a fraction of a share cannot be held in an ISA,” says an HMRC spokesperson.

“We have engaged extensively with the ISA sector on this issue.

“When an ISA manager allows investment in non-qualifying assets, we would seek to recover any tax loss from the ISA manager rather than the investor where possible.”