The OTS' key proposal (in Chapter 3 of the report) is that ERS should be taxable only when actually marketable, that is, when particular ERS can be sold (whether or not they are), by the relevant employee in his current circumstances (see paragraph 3.4 of the report), to a third party for an amount of money or money's worth approximately equal to the unrestricted market value (UMV) of the ERS at that time. The UMV would be the taxable value (except on an elected early taxation of forfeitable securities, as discussed below), but UMV would be replaced for that purpose by the actual value received on any disposal within 14 days after the taxable event. A tax charge would therefore arise either on acquisition of marketable securities, or when non-marketable securities already held became marketable. It seems that even listed shares would not be marketable securities whilst subject to restrictions on sale in an employee's hands.

[PLC comment: The report states at the beginning of Box 3.A that listed company shares "would automatically be marketable securities (except for shares subject to forfeiture)". This is not addressed very clearly, but we think that the OTS here assumes that forfeitable shares will also be subject to personal contractual restrictions on dealing during the forfeiture period and so not marketable. Looking at paragraphs 3.4 and 3.16, it seems that contractually non-marketable listed shares are intended not to be treated as marketable securities even when not also forfeitable.]

The OTS proposes that the employee and employer would be able to jointly elect for non-marketable ERS to be taxed on acquisition, in which case the taxable value would be the UMV that the ERS would have at that time if marketable. However, the new election would not be available (before the acquisition of securities) in respect of unexercised securities options or other rights to acquire securities (in practice, by far the most common of these are share options and share awards under long-term incentive plans). (The OTS considered and rejected a proposal for a "free-floating"election that could be made at any time between acquisition of non-marketable securities and them becoming marketable.)

The definition of RCAs would also be amended, so that ERS would not be RCAs unless marketable. As a result, ERS income tax would not be payable under PAYE, and National Insurance contributions (NICs) liabilities would not arise, unless the relevant ERS were actually marketable. There would be no PAYE and NICs as a result of an election for early taxation of non-marketable ERS.

The OTS proposes the retention of at least parts of Chapter 2 (restricted securities) of Part 7 of the ITEPA 2003, so that it would remain possible to elect for early taxation of the restricted market value of securities subject to a forfeiture restriction lasting less than five years (see section 425 of the ITEPA 2003). The possibility of this kind of election would supplement the general power to elect for taxation of non-marketable securities on an unrestricted value basis as if marketable (see the second paragraph of this section), but it would not be possible to effectively apply both types of election in respect of the same ERS. (If both types of election were to be made, the new election would take effect and the section 425(3) election would have no effect.) The OTS also proposes that it should be possible to elect for such securities to be taxed when the risk of forfeiture falls away, if they are still non-marketable at that time. (For more information about Chapter 2 of Part 7 and section 425 of the ITEPA 2003, see Practice note, Restricted securities: Forfeiture restriction lasting five years or less: exclusion of general earnings charge, Forfeiture restriction lasting five years or less: consider an election to pay a general earnings charge and The notional loan charge is deferred for restricted securities within the five-year forfeiture exception.)

As a result of the OTS' marketable securities proposals:

The report characterises these proposals as aligning ERS taxation more closely with the taxation of general earnings (see sections 6, 7 and 62 of the ITEPA 2003). At present, amounts related to ERS are taxed under Part 7 of the ITEPA 2003 as "specific employment income", rather than "earnings" falling within section 62. In many circumstances, a general earnings charge will arise on the acquisition of ERS. If so, there may be no Part 7 liabilities arising on the same securities, or Part 7 provisions may modify the initial general earnings charge, or they may give rise to subsequent additional charges on the same securities. There are also situations in which a Part 7 charge arises and there is no general earnings charge on the same ERS.

The OTS:

[PLC comment: These proposals deserve thorough assessment, which will take some time. The proposals will probably be welcomed by companies and advisers if they can become confident that the new approach would in fact reduce the tax obstacles to the use of ERS, as Part 7 of the ITEPA 2003 is notoriously complex, internally inconsistent and obscure, especially to employees and employers without ready access to specialist advice. However, it would seem to require a very significant government effort to consider and accept these proposals and then to draft legislation, and probably a significant parliamentary effort to enact them. So whether this can be done might depend on the volume of other, higher priority tax legislation in development at the same time. Given the long history of avoidance and anti-avoidance in the field of ERS and ERS options, it may also be difficult for the government to confidently move away from the current extensively amended version of Part 7, if it fears that might begin a new cycle of avoidance planning and anti-avoidance legislation.]

In connection with its marketable securities proposals (see Marketable securities), the OTS recommends (in Chapter 4 of the report) that Finance Bill 2014 should include amendments to three other aspects of ERS taxation, summarised in the following three sections.

[PLC comment: All of these recommendations could be usefully adopted even if the marketable securities proposals are not. They would be welcomed by companies using share schemes and their advisers.]

In respect of the tax and NICs treatment of internationally mobile employees' ERS and ERS options, the OTS recommends (in Chapter 5 of the report):

For more information about aspects of the taxation of IMEs' ERS and ERS options, see Practice note, HMRC guidance on share incentives for internationally mobile employees.

The OTS recommends (in Chapter 6 of the report) development of a safe-harbour employee shareholding vehicle (which would probably be an EBT). This should be more accessible to companies without the need for the expensive advice and services often currently required to successfully adopt and run EBTs to support share schemes and would:

The OTS does not suggest a timetable for enactment of this proposal and acknowledges the need to co-ordinate its development with the government's response to the Nuttall Review on employee ownership (for more information, see Legal updates, Nuttall review of employee ownership: government response and Share buybacks: BIS consultation on implementation of Nuttall Review). The OTS also acknowledges that EBTs have been widely used in tax avoidance schemes and so have become somewhat tainted in HMRC's view, and that robust anti-avoidance provisions will be required.

For more information about EBTs, see Practice notes, Trusts in commercial transactions: Employee benefit trusts and Practice note, Setting up an employee benefit trust: an overview.

[PLC comment: Although this has been addressed by the OTS in the context of unapproved share schemes, many of the same practical and legal difficulties can also arise for EBTs used to support tax-favoured share and share option schemes.]

In the short term (that is, in 2014), the OTS recommends (in paragraphs 7.11 - 7.15 of the report) retaining the current Form 42, despite the disproportionate complexities and burdens this imposes on some employers, but:

In the medium term (that is, in 2015, if not earlier), the OTS recommends (in paragraphs 7.16 - 7.17 of the report) targeting particular aspects of online Form 42 reporting appropriately to employers for whom they are relevant.

In the long term (that is, in 2016), the OTS recommends (in paragraphs 7.18 - 7.19 of the report) integrating online Form 42 reporting with RTI.

For more information about Form 42, see Practice note, Form 42: annual reporting obligations for employee securities (except tax-favoured arrangements).

The OTS recommends (in paragraphs 7.33 - 7.49 of the report) either:

For more information about the taxation of employment-related loans see Practice note, Loans to employees and directors: tax issues: Tax treatment of loans to employees and Loans to employees and directors: tax issues: Employment income tax charge when loan released or written off.

In respect of the authoritative valuation of ERS (mostly shares) for tax purposes, the OTS recommends (in Chapter 8 of the report) that, during the tax year 2013-14:

For more information about ERS valuation, see Practice note, Valuing employee shares.