HMRC clashes with young investors over Isa rules

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Tens of thousands of young UK investors could be forced to sell their holdings as a dispute between the tax authority and brokerage platforms threatens to undermine the government’s shake-up of tax-free Individual Savings Accounts.

Many UK trading apps offer investors the ability to hold fractional shares within Isas, enabling them to buy stakes in expensive US stocks such as Apple, Amazon and Tesla from just £1, rather than saving up hundreds of pounds to purchase a single share. 

HM Revenue & Customs held a meeting with industry figures and Treasury officials last week, during which it maintained that this type of investment could not be held within a tax-free account despite platforms disputing this interpretation of the rules.

Platforms had hoped that chancellor Jeremy Hunt’s desire to simplify “a complex landscape” of Isa products and encourage more people to save and invest would soften HMRC’s position. They have urged the chancellor to clarify his position in next month’s Autumn Statement.

Adam Dodds, chief executive of investing app Freetrade, wrote to customers on Friday encouraging them to lobby the Treasury on the issue, warning: “Your ability to hold fractional shares in your Isa is being put at risk by HMRC.”

“Isa rules need to be clarified to put this matter beyond doubt, explicitly allowing for fractional shares as a qualifying [Isa] investment,” he told the Financial Times.

British adults can save or invest up to £20,000 into an Isa each tax year, split between cash and other investments. No tax is payable on savings interest, dividends or capital gains, and withdrawals are not subject to income tax.

The Treasury said: “We want the Isa market to work for both the industry and consumers and are working on a range of options.”

If HMRC prevails, investors will be forced to sell down any fractional holdings within Isas, and could be required to pay tax on gains and face penalties for late payment.

HMRC, a non-ministerial government department, said: “Our longstanding view is that a fraction of a share cannot be held in an Isa. 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.”

Financial influencers and industry groups believe the move would deter a new generation of investors.

“Excluding [fractionals] from Isas at this stage would dent confidence and do irreparable damage in getting young people to invest in the first place,” said Peter Komolafe, founder of the popular Conversation of Money podcast and social media channel.

A video he shared on social media objecting to HMRC’s stance has been viewed more than 100,000 times. Many of his followers have questioned HMRC’s timing, noting providers including Freetrade, Moneybox and Trading212 have offered customers the ability to hold fractional shares within Isa accounts for several years.

The Investing and Savings Alliance (Tisa), a trade body, said it would only take a clarification of 1998 Isa rules to resolve the dispute rather than a big legislative change.

“We don’t think it would be helpful for HMRC to take a backward-looking stance because it could damage the reputation of the Isa,” said Lisa Laybourn, Tisa’s director of technical policy, stressing the benefits of allowing investors with small sums of money to start building tax-free investments for the future.

Nathan Matthews, 28, set up his Isa in March 2021, and has been investing £30 a month in companies including Meta, Starbucks and McDonald’s. “Fractional investing means I can afford to build a diversified portfolio and receive dividends even though I don’t have huge sums to invest,” he said, pointing out he would need more than £200 to buy a single McDonald’s share.

The clash threatens to undermine the government’s efforts to boost the appeal of Isas and encourage investment in equities more generally.