The FT ran a fascinating story yesterday about a dispute between HMRC and some ISA platforms over whether the ISA platforms can sell investors fractional shares. HMRC are saying the ISA rules don’t permit this.
HMRC is usually right, but in this case we think they’re probably wrong (perhaps misled by some confusing ESMA guidance).
This article aims to provide an explanation of the dispute, and why we think HMRC is probably wrong. That requires a reasonably detailed legal and tax analysis of the arrangements, so this article is somewhat more technical than our usual reports.1We are still considerably simplifying the underlying plumbing, but we believe the additional complexity doesn’t change the analysis. If you disagre, please write to us, or comment below. But it’s an important issue: we believe fractional shares are in the interests of investors (particularly young investors), and we believe the existing rules permit them.
We hope HMRC will reconsider its position, and start from a detailed English law/UK tax analysis of the effect of the arrangements, rather than from the ESMA guidance.
To understand the issues raised by fractional shares, we first have to explain how ISAs work with normal shares:
How shares work
If you open an ISA account with (say) Hargreaves Lansdown2We’re using Hargreaves Lansdown as an example; they don’t actually offer fractional shares, and pay £1,100 to buy ten AstraZeneca shares, what happens?
Important caveat up-front: all of the below relates to English law arrangements only – it should be correct where shares are held through CREST but may or may not be correct for comparable foreign law arrangements, and the analysis can sometimes be very involved.
Ownership
You don’t actually own ten AstraZeneca shares.
Hargreaves Lansdown has a “pooled omnibus account” in which all its customers’ shares are held. Let’s imagine it used to hold 99,990 AstraZeneca shares. When you clicked the button to buy ten shares, Hargreaves Lansdown bought another ten in the market3Simplification alert – it’s much more complicated than this. In particular, Hargreaves Lansdown will have numerous buy and sell trades on the same security, and only trades out its net position in the market (so you may actually be buying your shares from another Hargreaves Lansdown customer, albeit at the market price). For the purposes of this article “the market” will do., so the account now holds 100,000 AstraZeneca shares.
None of those 100,000 shares are “yours” in the sense that they are labelled with your name. Or indeed in any legal sense.
What you have instead is an “undivided beneficial interest” in all of the shares. To be precise, you own 0.01% of the pool (i.e. 10 divided by 100,000), and therefore you own 0.01% of each share. Legal ownership of the shares (i.e. the person shown in the share register) is with Hargreaves Lansdown.4I am again simplifying; the precise arrangements with CREST etc are more complicated than this, but the principle is the same. In legal terms, Hargreaves Lansdown are the nominee or trustee, and the investors are the beneficiary.
It’s worth repeating this, because it’s so counter-intuitive: your ISA app shows you holding ten shares. In realistic, economic, commercial terms, you own ten shares. But in legal terms you don’t own ten shares at all – you own 0.01% of 100,000 shares.5To be more pedantic: you don’t have legal ownership of any shares; Hargreaves Lansdown does. You have an undivided beneficial interest of 0.01% in their pool of 100,000 shares. English law uses the term “legal” to mean “owner on the face of the documents” and beneficial to mean “economic ownership which the law will enforce as if you owned it directly” (I am again simplifying, but this is a good rule of thumb).
Dividends
When AstraZeneca pays a dividend, they pay it to Hargreaves Lansdown, and you own 0.01% of that dividend.
Voting
If you vote to oppose the directors’ remuneration report then Hargreaves Lansdown will cast that vote on 0.01% of their shares. Not “your shares”, but any ten shares that they picked randomly.
Selling
If you later sell your shares, then it is absolutely not the case that Hargreaves Lansdown identifies the ten shares you own, sells those, and gives you the proceeds. You don’t own ten shares. You own 0.01% of 100,000 shares. They sell ten of those shares in the market6Again, it’s more complicated than that, and HL are trading the net position, but we’ll ignore that to keep this article under 100,000 words – and then you have a 0% interest in the remaining 99,990 shares. The £110 proceeds of the sale goes into a cash bank account, and you will acquire an interest in that account (e.g. if there is £1.1m in the cash account then you will beneficially own 0.01% of the account). Your account will then show you as holding £110 of cash. Just like with the shares, there obviously isn’t £110 sitting in a pot with your name on it; cash is “fungible” (all cash is mutually interchangeable) in the same way as shares.
The implications
This isn’t just mechanics – it has legal reality to it. If Hargreaves Lansdown goes bust, then the only people entitled to the AstraZeneca shares are the ISA investors – because they own them. The investors only lose out if the shares aren’t in that account; and modern custody arrangements mean that really shouldn’t be able to happen (absent a very sophisticated and implausible insider fraud involving multiple people).
This is how most retail share ownership works. It has the advantage of being efficient and scalable – no need to create a separate account for each customer. The disadvantage7Possibly there is an additional disadvantage that a pooled omnibus account is more susceptible to losses from fraud/error than if you had your own “segregated” account. However, it’s not clear if this is really the case in practice. A good test here is whether veteran regulatory and insolvency lawyers insist that their own investments are held in segregated accounts – in the authors’ experience they don’t. is that AstraZeneca only sees Hargreaves Lansdown as the shareholder; AstraZeneca has no idea who the beneficial owners are. If you, with your ten shares held through Hargreaves Lansdown, write to AstraZeneca and ask them to pay you a dividend, they’ll rightly refuse. If you try to go to a shareholder meeting, they won’t let you in.8These days, that’s not quite right, as some providers have systems and arrangements that let ISA investors attend meetings, but the important point is that Hargreaves Lansdown has to facilitate this; otherwise AstraZeneca won’t treat you as a shareholder.
The whole system is designed so that investors (from the largest hedge fund to your granny) don’t have to think about the plumbing. They can say, very comfortably, that they own ten shares. Their app says they own ten shares. Economically, they do own ten shares. But legally that is not quite how it works.
The rest of this article won’t make sense if the above didn’t make sense. Hopefully it does – if not, please drop us a line and we will try to make it as clear as we can.
Fractional shares
It’s useful to allow investors to buy fractions of shares. Some shares are expensive, and a small investor wouldn’t want to buy a whole one, particularly if they’re (sensibly) making small monthly additions to their portfolio. Fractional shares are also convenient for larger investors. If someone wants to invest £500 in AstraZeneca shares, then it’s a bit annoying to instead have to pay £440 for four shares. What they really want is to pay £500 for 4.545 shares, and get 5p change. In fact there’s a good argument that all retail share ownership should offer fractional holdings as the default.
These issues are magnified for some US shares. NVR, Inc. shares trade at over $6,000 – so it’s not just small investors who’d want to buy a fractional share.9The exemplar of this is Berkshire Hathaway, whose Class A shares currently trade at over $500,000 – but the company created a much smaller denomination Class B shares twenty years ago which now trade at around $350.
You’ve always been able to buy fractional units in a unit trust, but as a matter of company law, fractional shares don’t exist (at least in the UK and US).
Some providers have, nevertheless, found ways to offer fractional interests in shares to UK ISA investors. We will call the product “fractional shares” for clarity, although strictly there is no such thing.10There is no contradiction here; it’s common for beneficial ownership of an asset to be split between different parties when legal ownership cannot be split.
They do this in two ways.
- One approach is to simply agree in a contract with the investor that they’ll get exactly the same return as if they bought a fraction of a share. They don’t actually own any shares – they just have a contract with the provider – a kind of derivative. It’s clear a derivative can’t go in an ISA11Because it isn’t legally “shares” even if it economically behaves like shares, and we don’t think anyone would disagree with that. Another important element: only sophisticated investors should be buying this product, and extensive disclosure would be required of the risks created by the product.12In particular, it may not exactly track the value of the share, and it will leave the investor exposed if the provider goes bust, because they don’t actually own any shares.
- They can simply use the normal ownership arrangement, tweak some of the mechanics slightly, and give the investor a fractional interest in shares. This is the kind of arrangement that the FT article was discussing.
The rest of this article will look at how the second solution works, and whether it can go into an ISA. We’ll ignore the “derivative” structure for the rest of this article.
Full disclosure: neither Dan Neidle nor the other contributors to this article own any fractional shares, or have any interest in or relationship with the affected providers.
How fractional shares work
Let’s take the AstraZeneca example above, and replace the ten shares in the example with a fractional 0.1 share.
When you buy the 0.1 shares, you pay £11 and receive an undivided beneficial interest of 0.0001% in each share in the omnibus account. Now, Hargreaves Lansdown didn’t just go out and buy 0.1 shares in the market, because that’s not possible. Instead, Hargreaves Lansdown “topped-up” the trade to the nearest whole trade,13Again, in the interests of simplicity, we’re ignoring the fact that brokers only trade their net position. The more accurate way to put this is “if the net position includes a fraction then Hargreaves Lansdown tops up/down the trade to the nearest whole number of shares”. and bought one share for £110 – 0.1 of that share is for you, and the other 0.9 is for Hargreaves Lansdown (so Hargreaves Lansdown own 0.0009% of the omnibus account).14Or perhaps they’ve already done this for another customer, in which case Hargreaves Lansdown are selling 0.1 of “their” share to you. And again there’s the complication that Hargreaves Lansdown only trade the market for their net position
You’re entitled to 0.0001% of the dividends – that’s easy.
Selling also hits the snag that Hargreaves Lansdown can’t actually sell fractional shares to the market,15Again, in the interests of simplicity, we’re ignoring the fact that brokers only trade their net position. The more accurate way to put this is “if the net position includes a fraction then Hargreaves Lansdown rounds up/down the trade to the nearest number of whole shares, and if there’s an excess then Hargreaves Lansdown holds the residual fraction of the excess share themselves”. so (broadly speaking) they’ll acquire your 0.0001% interest themselves, and pay you in cash for it (from their “float”).
Voting is also different. If you hold a 0.1 fractional share, want to vote against the directors’ remuneration report, and no other fractional shareholders do, then you’re out of luck. The Companies Act doesn’t permit Hargreaves Lansdown to vote on a fraction of a share. If in fact there are 100 people all owning 0.1 fractions, and half of them want to vote against the report then it’s easy: Hargreaves Lansdown votes that way on ten shares. But if there are 101 people, then Hargreaves Lansdown still votes that way on ten shares, so in a philosophical sense someone’s vote has been “lost” (but not an identifiable person).
Finally: transfers. You can transfer your account to another provider. Quite often there are systems/operational reasons why some of the securities can’t transfer. For example it may be a special unit that’s only offered to customers of the old provider, or it may be a security of a type that the new provider’s systems can’t handle (e.g. US$ denominated securities). In that case, the awkward securities are sold, and the new provider receives the cash, plus the nice straightforward securities. Fractional shares will always fall in the “awkward” bucket.
And some providers – but not all – let you transfer individual securities – either out of an ISA account to yourself, or to a third party (“in specie transfers“). You can’t do that with fractional shares.
What is HMRC’s position?
We understand that HMRC believes that fractional share ownership shouldn’t be permitted from a policy perspective. We would speculate this is influenced by a statement from ESMA earlier this year, which said most fractional share ownership is via derivatives – this is not accurate in relation to the UK market. The statement added that derivative fractional ownership is problematic from a regulatory perspective – that is a sensible conclusion. But then, significantly, it also said:
“It should be noted, however, that other structures of fractional shares [i.e. other than derivatives] also raise some investor protection concerns and that some of the clarifications given in this statement may also be relevant for such structures.”
Our regulatory contacts did not understand what the “concerns” referred to might be. It is possible that ESMA misunderstands how fractional share ownership works, or is thinking about a variety of fractional share ownership used in some jurisdictions/circumstances, but not relevant to the UK. But we would speculate that this has influenced HMRC’s approach.
So this policy justification seems wrong. But it’s not strictly relevant. The only real question is: what does the law say?
We believe the key legal questions are as follows:
1. Are fractional shares “shares”?
The ISA regulations only let you hold certain things in an stocks and shares ISA – “qualifying investments”, as defined in regulation 7:
HMRC take the view that a fractional interest is not a “share”. They told us:
“Our long-established and clear position is that ‘shares’, as referred to (for example) in Regulations 7(1) and 7(2)(a) of The Individual Savings Account Regulations 1998, refers only to whole shares and not part thereof. Fractional shares are not a whole share and therefore cannot be held in an ISA.”
In our view it is reasonably clear HMRC are wrong, for the simple reason that all shares held in an ISA are fractional interests.
In our original AstraZeneca example, the investor with “ten shares” actually holds 0.01% of 100,000 shares. In the fractional share example, the investor with “0.1 shares” actually holds 0.0001% of 100,000 shares. Both are fractional shares; there is no tax or legal distinction between the two.
Neither is a problem, because when we read the word “shares” in regulation 7, we should read it as “a beneficial interest in shares”. The ISA regulations are incorporated into income tax and capital gains tax legislation, and that’s how we apply income tax and capital gains tax.
Now you could say “but the difference is that it is actually possible to own ten shares; it isn’t possible to own 0.1 shares”. That is true, but we are unaware of any legislation or caselaw which makes that relevant to the legal test. If it was the case that fractional ownership of something changed the nature of that thing for income tax and capital gains tax purposes, then weird things would happen and you could play all kinds of fun games with the rules (yes you can’t own 0.1 of a share, but you also can’t own 0.1 of a freehold building… but plenty of people do).
Another way to put that argument is to say that (in our example) Hargreaves Lansdown can’t actually buy or sell 0.1 of a share, so the investor doesn’t have an interest in it. That is simply wrong: they are buying and selling beneficial ownership of 0.1 of the share. They can’t buy or sell legal title to 0.1 of the share, but – again – that’s true for real estate and all kinds of other property, and it doesn’t mean you can’t hold a fraction of it.16The rule in Saunders v Vautier is not that any one beneficiary can call for the trust property; it’s that the beneficiaries together can call for the trust property.
So a fractional interest in a “share” is, in our view, a share – just as much as a conventional non-fractional shareholding. Indeed we understand that providers use the same legal documentation for fractional shares as for “normal” shares (with minor tweaks); the nature of the ownership is the same. 17A further point: if I was HMRC I’d be wary about putting any of the above arguments to a tribunal/court. If HMRC somehow won, and established the principle that you can transform an asset to another type of asset via nominee arrangements and fractional ownership, that would create considerable uncertainty and potentially enable new forms of avoidance.
A final point to note: we understand that the FCA accepts that fractional shares are fractional interests in shares, and considers them covered by CASS 6.
2. Do the transfer mechanics breach the ISA Regulations?
The ISA Regulations say providers must, at a client’s request, move their account to another provider. Regulation 4(6)(f) says that the provider’s T&Cs must secure:
Ideally all the shares in the account would move with it, and technically that means the shares have to be transferred from the old provider to the new. However any fraction can’t move; instead it will be sold, and the cash proceeds moved with the account to the new provider.
We understand HMRC have suggested this means Regulation 4 is failed.
We don’t agree. As we noted above, it’s fairly common right now with ISA transfers that “awkward” securities can’t be transferred, and have to be sold, with the cash proceeds moved with the account to the new provider.
It’s the same with fractional interests in shares.
Why is that okay under the Regulations? Probably because “all the rights and obligations of the parties” mean the basic terms of the account (and critically the aggregate value in cash/securities in the account). It doesn’t mean that every security in the account has to transfer; but if it did, many providers existing/non-fractional arrangements would be breaking the Regulations. Regulation 4(6)(f) shouldn’t be read too literally – from a literal legal point of view an account cannot be transferred, and will not be transferred… rather a new account will be created by the new provider with similar characteristics. Regulation 4(6)(f) necessarily operates in a pragmatic commercial world, not a literal one.
So we don’t think fractional ownership arrangements break the transfer requirement in the Regulations.
Nor do we think it’s relevant that customers can’t request in specie transfers of fractional shares. Plenty of providers don’t offer in specie transfers at all, and it’s not a requirement of the ISA Regulations that they do.
3. Do voting and meeting restrictions make a difference?
Now we come to HMRC’s best argument. Regulation 4(6)(d) says that the provider’s T&Cs must secure:
As we note above, the investor will sometimes not be able to vote, and (if their fraction is less than one) will never be able to attend a meeting. So is this a breach of the Regulations?
We think probably not. The provider just uses its standard terms, which includes the right to vote and attend meetings. That itself may be enough – Regulation 4(6)(d) doesn’t explode an ISA if voting can’t happen in a particular case; it merely says what the terms should contain.
Clearly the terms saying an investor can attend a meeting doesn’t mean the investor will always be able to attend a meeting. Why? Because UK company law doesn’t permit a vote to be cast on a fraction of a vote, or a fractional shareholder to attend meetings. But that is a “provision under an enactment”, and therefore there is probably no breach of regulation 4.
That is, however, not entirely clear, and this is why we say at the top of this article that HMRC are “probably” wrong.
Conclusion
We hope that, on a full consideration of the legal and tax analysis, they agree that the better view is that fractional shares are permitted by the existing ISA rules. We don’t see a public interest in HMRC pursuing a point that is (at best) marginal.
This article is our legal and tax analysis of the fractional share dispute, prepared to assist public debate. It is not legal advice and cannot be relied on by investors, providers, or any other party.
Thanks to A for his in-depth knowledge of omnibus account and custody/dealing mechanics, F and K for their ISA regulations expertise, T for regulatory insight, and the industry contacts who kindly provided us with the background to the dispute.
And, finally, thanks to Rafe Uddin and Claer Barrett for the story that piqued our interest in this.
Photo by Tech Daily on Unsplash.
- 1We are still considerably simplifying the underlying plumbing, but we believe the additional complexity doesn’t change the analysis. If you disagre, please write to us, or comment below.
- 2We’re using Hargreaves Lansdown as an example; they don’t actually offer fractional shares
- 3Simplification alert – it’s much more complicated than this. In particular, Hargreaves Lansdown will have numerous buy and sell trades on the same security, and only trades out its net position in the market (so you may actually be buying your shares from another Hargreaves Lansdown customer, albeit at the market price). For the purposes of this article “the market” will do.
- 4I am again simplifying; the precise arrangements with CREST etc are more complicated than this, but the principle is the same.
- 5To be more pedantic: you don’t have legal ownership of any shares; Hargreaves Lansdown does. You have an undivided beneficial interest of 0.01% in their pool of 100,000 shares. English law uses the term “legal” to mean “owner on the face of the documents” and beneficial to mean “economic ownership which the law will enforce as if you owned it directly” (I am again simplifying, but this is a good rule of thumb).
- 6Again, it’s more complicated than that, and HL are trading the net position, but we’ll ignore that to keep this article under 100,000 words
- 7Possibly there is an additional disadvantage that a pooled omnibus account is more susceptible to losses from fraud/error than if you had your own “segregated” account. However, it’s not clear if this is really the case in practice. A good test here is whether veteran regulatory and insolvency lawyers insist that their own investments are held in segregated accounts – in the authors’ experience they don’t.
- 8These days, that’s not quite right, as some providers have systems and arrangements that let ISA investors attend meetings, but the important point is that Hargreaves Lansdown has to facilitate this; otherwise AstraZeneca won’t treat you as a shareholder.
- 9The exemplar of this is Berkshire Hathaway, whose Class A shares currently trade at over $500,000 – but the company created a much smaller denomination Class B shares twenty years ago which now trade at around $350.
- 10There is no contradiction here; it’s common for beneficial ownership of an asset to be split between different parties when legal ownership cannot be split.
- 11Because it isn’t legally “shares” even if it economically behaves like shares
- 12In particular, it may not exactly track the value of the share, and it will leave the investor exposed if the provider goes bust, because they don’t actually own any shares.
- 13Again, in the interests of simplicity, we’re ignoring the fact that brokers only trade their net position. The more accurate way to put this is “if the net position includes a fraction then Hargreaves Lansdown tops up/down the trade to the nearest whole number of shares”.
- 14Or perhaps they’ve already done this for another customer, in which case Hargreaves Lansdown are selling 0.1 of “their” share to you. And again there’s the complication that Hargreaves Lansdown only trade the market for their net position
- 15Again, in the interests of simplicity, we’re ignoring the fact that brokers only trade their net position. The more accurate way to put this is “if the net position includes a fraction then Hargreaves Lansdown rounds up/down the trade to the nearest number of whole shares, and if there’s an excess then Hargreaves Lansdown holds the residual fraction of the excess share themselves”.
- 16The rule in Saunders v Vautier is not that any one beneficiary can call for the trust property; it’s that the beneficiaries together can call for the trust property.
- 17A further point: if I was HMRC I’d be wary about putting any of the above arguments to a tribunal/court. If HMRC somehow won, and established the principle that you can transform an asset to another type of asset via nominee arrangements and fractional ownership, that would create considerable uncertainty and potentially enable new forms of avoidance.
29 responses to “Fractional shares and ISAs – HMRC are probably wrong”
Do ADRa (and more generally depositary receipts) qualify?
yes, if the underlying shares are qualifying. Although not all providers permit this.
Hargreaves Lansdown have consistently refused to let GameStop shareholders vote their shares, and they also refuse to allow direct registration of GameStop shares held in an ISA, which would permit voting.
Direct ownership of shares (especially US shares) is starting to get a lot of attention because it seems to be the only tool small investors have to fight back against short sellers driving the price down by selling ‘shares’ that they don’t have, so I really hope HMRC doesn’t drop this, I would greatly value being able to actually own the shares in my Hargreaves Lansdown ISA, and it seems at first glance that Regulation 4(6)(d) says I have the right to do that.
Again, I have no idea why anyone thinks fractional shares is anything to do with voting on shares.
HL run a (relatively) cheap service, and one consequence of that is that you can’t vote on US shares. If you don’t like that, pay more and sign up with someone who does allow voting on US shares. Once more: zero to do with fractional shares.
If you sell ten shares of AstraZeneca why you don’t get 1100£ but as mentioned in the example only 110£? Is it example assumption that the seell share price is 11£ only?
Great piece which explains the mechanics in depth! I have one follow-up question:
How is the fractional shares custodied? Let’s say a trading platform offering fractional shares only has a single customer who buys 0.5 Tesla stocks against which the trading platform acts as a principal (Freetrade, say). Consequently, after buying 1 Tesla stock in the market, the client now owns 0.5 shares and Freetrade owns the other 0.5 shares.
Freetrade, like all other brokers, must segregate client securities from their own securities (meaning that they effectively have two securities accounts, one for their own holdings and one omnibus account for client securities).
Is the single share owned by Freetrade and the client collectively subsequently placed in the client custody account or inthe Freetrade securities account?
If the former, then the client is “oversecured” in the event of bankrupcy while in the latter, investor protection is compromised.
Has anyone seen concrete documentation for the above and how it potentially impacts investor-protection?
It’s in the client account, and so the client is an itsy-bitsy bit oversecured…
Hi
I made a petition on the Parliament petions website
https://petition.parliament.uk/petitions/649135
Could someone spell out in plain language if ETFs will still be OK to hold in an ISA?
Haven’t looked into it properly, but I believe ETFs are classified differently and so there isn’t a controversy around their treatment.
HMRC’s current approach fails any public interest hurdle.
There is no defrauding of the public purse, there is no defrauding of individuals – there is merely an acceptance of floating-point division rather than integer division that removes any penalisation of small-scale investors.
Even if HMRC is right in the text of the law, they are being an ass.
The best way for everybody to close this is for Jeremy Hunt to instruct a concession to make it explicitly allowed – who will object?
HMRC should be focussing on people who are defrauding the public purse – Property118 etc.
“HMRC should be focussing on people who are defrauding the public purse – Property118”
How are property 118 defrauding the public purse? It was George Osborne who changed the tax laws on landlords. I dont understand if Property 118 tax solution works or it does n’t. It is n’t fair on people. It is a grotesque waste of money to spend on tax advisors, then on builders who can improve the property.
What about REITs?? Is it fair.
Landlords paying 8.5% on their mortgage. It is n’t worth being a landlord. The landlord is forced to sell up.
No one looks at the “human” element, which is the tenant are told they their tenancy will not be renewed and force to find another property. However, there is a shortage of property, as other landlords are thinking the same and selling up.
The only people who did well are the HMRC and the tax advisors.
There absolutely is a public interest, in protecting investors in US shares from short sellers.
In the US stock market, it’s possible for some short sellers to sell shares they don’t own, if they follow a few very lax rules about showing they could conceivably acquire them later. If the company goes bust before the shares sold are purchased, the short seller’s obligation to buy goes away too, leasing them with pure profit. This can lead to many more ‘shares’ being sold on the US market than were issued by the company, which drives down the share price.
this is absolutely nothing to do with fractional shares.
Really interesting piece and legal argument I hadn’t considered.
But young and small scale investors would be much better off with a fund, IT or ETF than punting on a fractional slice of one share. Not sure it’s great public policy to encourage this investment error.
Small typo in FN9, I’m pretty certain that Berkshire Hathaway’s B shares are around $350 and not $3.50!
Thanks for the article, interesting as always.
Hi there Dan,
We do not have fractional shares or any such arrangements in Portugal, but HMRC behavior could be followed by PTA. Might one presume that this non Tax (excluding Fractional from ISA) answer is because they do not know very well how to tax characterize the income of the fractional shares in the ISA (therefore not allowing the investment is just a scapegoat)? For instance, I guess Hargreaves Lansdown might use some kind of dividend participation exemption (PE) mechanism if they own enough shares (I do not know if UK has a beneficial ownership clause to break this). The question then would be If I owned enough fractional shares to meet the PE requirement in my ISA, could I use it (after all, I am the real beneficial owner on the ISA)? Maybe PE on ISA is not the best example if the ISA is fully exempt – sorry but we also do not have these type of structures here in Portugal -, but I am sure a similar example might be thought of. Kind regards, Miguel
Thanks for the useful article, Dan. Not sure I agree with you that HMRC is usually right! But otherwise very useful.
Having done a lot of tax work for financial institutions and looked in detail at their terms and conditions, is that it is not always the case (as per your footnote 5) that you have a beneficial interest in their pool of shares. That is sometimes the case – but only typically where English or Scottish law applies – and even then not all the time. With many cases (indeed possibly the majority – and almost always when foreign law is involved) the arrangement is based on contract law rather than trust/nominee law. So in many cases what you technically own is a chose-in-action, namely a contractual right against “Hargreaves Lansdown”….all of which probably makes your point more strongly – because then even if you have non-fractional shares, you don’t in fact even have beneficial ownership of shares (which, if HMRC pushed their point, would mean that no-one could qualify for ISA treatment). Given also that a share is merely a bundle of rights against the underlying company, all of this makes HMRC’s view all the more of a nonsense here.
thanks – you are absolutely right. I should have said I am making the important assumption that the arrangements are English law. Undertaking a comparable UK tax analysis for foreign law securities systems can in my experience be a total nightmare!
As a retail investor I was a little worried about this -was considering writing my MP.
Have you sent a link to this to the govt ? I hear Jeremy Hunt is keen on promoting share ownership…
Thanks
Writing to MPs and Jeremy Hunt is a good idea – investors probably more persuasive than I will be!
I found the explanation’s pretty easy to follow. Would be helpful to add something about who ESMA are and why HMRC might be influenced by them.
Is the contention in the first part that you have a very small beneficial interest in all the shares rather than a full interest in the number of shares you actually paid for based on eg that the HL nominee company is a bare trust?
correct
HMRC also takes a similar view with the tax advantaged share plans. For example, this is the HMRC manual on share incentive plans: https://www.gov.uk/hmrc-internal-manuals/employee-tax-advantaged-share-scheme-user-manual/etassum24530
“It is also not possible to award a fraction of a share”
This is in the context of employees being given “matching shares” based on how many shares they buy personally (“partnership shares”). So, for example, the employee might get 0.5 shares for every share that they buy. On the face of it, this is bad for employees because the rounding down means that they will get less matching shares than the company has offered them.
But HMRC recognise this unfairness so they create a concession that is not in legislation by explaining:
“therefore if the award ratio does not result in a full share, the award should be rounded down to the nearest whole share and HMRC allow any fraction of a share balance to be carried forward to be added to the next award. Although the legislation (paragraph 59(1)(b)) requires matching shares to be awarded on the same day as the partnership shares to which they relate, HMRC has accepted wording in the SIP rules such as “If the partnership shares acquired on the day referred to in ‘Rule ?’ are not sufficient to produce a whole matching share, the match shall be made when sufficient partnership shares have been acquired to allow at least one matching share to be appropriated”.”
So their strict treatment on a share not including a fractional share means that employees might be disadvantaged. For example:
– if they leave before they get enough fractions together to get a whole share,
– the employer does not remember the fractional share that the employee didn’t get, or
– it takes so long that employees can’t hold the shares long enough to qualify for the tax relief.
It also means that, if the employer can be bothered, it has to have some notional accounting to remember what fractional shares have been promised but not yet awarded.
Matching ratios are up to the employer so they could create round numbers but a common one is to replicate a US 423 plan that gives a 15% discount (so the employee gets 15/85th of a share for each one they buy).
So hopefully, you will be able to get HMRC to extend their thinking to tax advantaged share plans to.
interesting – I’m not myself familiar with those rules so can’t say if similar issues arise
I’ve never found analysing trust arrangements easy but I thought the situation with ISAs and managers’ nominee companies was a bare trust. You have a right to (and beneficially own) ten shares registered in the name of HL Nominees Ltd (or whatever). HL maintains accounting records that reflect this. The shares held by the nominee company are not pooled but they are unallocated, until a transaction occurs. It is the bare trust that makes fractional shares inconsistent with an ISA.
As for inadvertently creating an unauthorised unit trust scheme or the correct analysis of the SDRT liabilities, I don’t want to go there.
I’m looking forward to everyone explaining in simple terms why I’m wrong!
no, the essence of a bare trust is that you must have an undivided beneficial interest in all the trust property. The trust property is all of the HL Nominees shares, not just your ten.
(I guess one could imagine having HL Nominees declaring a series of separate trusts over different shares, but the fact the shares are fungible means that (unless they were all in different accounts) the trust would fail for lack of certainty of property)
If the shares are fungible then why can’t you argue that it is *the same* to have your interested represented by the smaller number of full shares rather than the larger number of fractions? Is there any case law applying this to shares?