{"id":12109,"date":"2023-10-12T10:18:20","date_gmt":"2023-10-12T09:18:20","guid":{"rendered":"https:\/\/www.taxpolicy.org.uk\/?p=12109"},"modified":"2023-10-13T08:58:33","modified_gmt":"2023-10-13T07:58:33","slug":"fraction","status":"publish","type":"post","link":"https:\/\/heacham.neidles.com\/2023\/10\/12\/fraction\/","title":{"rendered":"Fractional shares and ISAs – HMRC are probably wrong"},"content":{"rendered":"\n

The FT ran a fascinating story yesterday<\/a> 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.<\/strong><\/p>\n\n\n\n

HMRC is usually right, but in this case we think they’re probably wrong<\/strong> (perhaps misled by some confusing ESMA guidance).<\/strong><\/p>\n\n\n\n

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.1<\/a><\/sup>We 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.<\/span> But it’s an important issue: we believe fractional shares are in the interests of investors<\/a> (particularly young investors), and we believe the existing rules permit them. <\/p>\n\n\n\n

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.<\/p>\n\n\n\n

To understand the issues raised by fractional shares, we first have to explain how ISAs work with normal shares:<\/p>\n\n\n\n

<\/div>\n\n\n

How shares work<\/h2>\n\n\n

If you open an ISA account with (say) Hargreaves Lansdown2<\/a><\/sup>We’re using Hargreaves Lansdown as an example; they don’t actually offer fractional shares<\/span>, and pay \u00a31,100 to buy ten AstraZeneca shares, what happens?<\/p>\n\n\n\n

Important caveat up-front: all of the below rates 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. <\/p>\n\n\n\n

Ownership<\/strong><\/p>\n\n\n\n

You don’t actually own ten AstraZeneca shares.<\/p>\n\n\n\n

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 market3<\/a><\/sup>Simplification 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.<\/span>, so the account now holds 100,000 AstraZeneca shares.<\/p>\n\n\n\n

None of those 100,000 shares are “yours” in the sense that they are labelled with your name. Or indeed in any legal sense.<\/p>\n\n\n\n

What you have instead is an “undivided beneficial interest” in all<\/strong> 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.4<\/a><\/sup>I am simplifying; the precise arrangements with CREST etc are more complicated than this.<\/span> In legal terms, Hargreaves Lansdown are the nominee or trustee, and the investors are the beneficiary.<\/p>\n\n\n\n

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.5<\/a><\/sup>To 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.<\/span><\/p>\n\n\n\n

Dividends<\/strong> <\/p>\n\n\n\n

When AstraZeneca pays a dividend, they pay it to Hargreaves Lansdown, and you own 0.01% of that dividend. <\/p>\n\n\n\n

Voting<\/strong><\/p>\n\n\n\n

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.<\/p>\n\n\n\n

Selling<\/strong><\/p>\n\n\n\n

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 market6<\/a><\/sup>Again, it’s more complicated than that, and HL are trading the net position, but we’ll ignore that to keep this article under 10,000 words<\/span> – and then you have a 0% interest in the remaining 99,990 shares. The \u00a3110 proceeds of the sale goes into a cash bank account, and you will acquire an interest in that account (e.g. if there is \u00a31.1m in the cash account then you will beneficially own 0.01% of the account). Your account will then show you as holding \u00a3110 of cash. Just like with the shares, there obviously isn’t \u00a3110 sitting in a pot with your name on it; cash is “fungible” (all cash is mutually interchangeable) in the same way as shares.<\/p>\n\n\n\n

The implications<\/strong><\/p>\n\n\n\n

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 insider fraud involving multiple people). <\/p>\n\n\n\n

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 disadvantage7<\/a><\/sup>Possibly 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.<\/span> 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.8<\/a><\/sup>These days, that’s not quite right, as some providers have systems and arrangements<\/a> 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.<\/span><\/p>\n\n\n\n

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 how it works.<\/p>\n\n\n\n

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. <\/p>\n\n\n

Fractional shares<\/h2>\n\n\n

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 \u00a3500 in AstraZeneca shares, then it’s a bit annoying to instead have to pay \u00a3440 for four shares. What they really want is to pay \u00a3500 for 4.545 shares, and get 5p change. In fact there’s a good argument that all<\/strong> retail share ownership should offer fractional holdings as the default.<\/p>\n\n\n\n

These issues are magnified for some US shares. NVR, Inc. shares trade at over $6,000<\/a> – so it’s not just small investors who’d want to buy a fractional share.9<\/a><\/sup>The 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.<\/span><\/p>\n\n\n\n

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). <\/p>\n\n\n\n

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.10<\/a><\/sup>There 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.<\/span> <\/p>\n\n\n\n

They do this in two ways.<\/p>\n\n\n\n