HMRC will once again be treated as a preferential creditor for insolvencies after 6 April 2020.
The HMRC were historically, many decades ago were higher in the pecking order when it came to making distributions in an insolvency case. Then in the Enterprise Act 2003, legislation changed so that they ranked as unsecured creditors along with the rest of creditors in insolvency.
As a result of the significant amount of taxes lost by HMRC a petition was put out by then to claim their preferential status back.
So, from April 2020 in Administrations and Liquidations, HMRC will move up the rankings and will get paid out first, jumping ahead of floating charge and unsecured creditors.
Currently, the preferential creditors are, employees and the Financial Services Compensation Scheme (FSCS) in insolvency cases. The HMRC will join be in line with the FSCS as a secondary preferential creditor in relation to outstanding taxes ‘paid’ by employees and customers that are held by a business on their behalf, such as PAYE, VAT, employee NICs and Construction Industry Scheme (CIS) deductions.
For corporation tax and any other taxes owed directly by a company, HMRC will remain as an unsecured creditor.
It is important to note that the legislation does not include a cap on the age of tax debts which can have preferential status. Prior to XXXX there was limit on the claim of six months VAT and 12 months PAYE debt which were classed respectively as preferential debts.
At present the following rules apply in terms of hierarchy: –
Fixed Charge creditors
Employees (ordinary preferential creditors)
FSCS – Secondary preferential creditor
Prescribed part carve out
Floating charge creditors
Unsecured creditors including HMRC
From April 2020
Fixed Charge creditors
Employees (ordinary preferential creditors)
HMRC – VAT, PAYE, Student loans, Employers NICs CIS – Construction Industry Scheme deductions and FSCS secondary Preferential creditors
Prescribed part carve out
Floating charge creditors
Unsecured creditors including HMRC with all the other taxes due
Lenders will be affected
HMRC has indicated that this will mean when a business becomes insolvent, more of the taxes paid in good faith by that business’ employees and customers will fund public services, rather than these being distributed to other creditors such financial institutions. Lenders will need to and, in some cases, have already started to be more diligent in the potential implications that this may have. There will be some immediate implications.
The returns to unsecured creditors historically have had very little hope. However, this change will significantly affect the way they are treated.
The largest creditor by far in most insolvency cases is HMRC. After April 2020, they will benefit from distributions from insolvency cases which would previously have been set aside for unsecured creditors.
There is also the risk attached to creditors with floating charge security
The claims from HMRC will take priority over any floating charges held by secured creditors. In some cases, these are asset backed debts provided by financial institutions. Floating charge assets are usually things like receivables, cash and stock.
The introduction of this new legislation will mean that floating charge assets could lose security value overnight.
Pre-insolvency planning
If a company within a bank’s portfolio is experiencing cash flow difficulties, these new rules will most probably change the options available to the bank. It could be tricky for the bank to commence legal proceedings for the recovery of the debt as this may reduce the return compared to considering a turnaround scenario or restructuring.
Secured creditors will need to think very carefully about the way they lend money.
Asset-backed lending
There will also be a negative impact on asset backed lending. Lenders have been able to support companies in their growth strategy by relying on the floating charge assets as security. This could be inventory facilities or loans secured by cash flow. With funds available for floating charge security potentially being significantly reduced, it could mean that asset backed lenders reduce or withdraw their levels of finance. As the new rules will affect the whole market equally, it will become increasingly challenging to refinance facilities with alternative funders, even if the lending market remains as buoyant as it is today.
Action for lenders
Carefully consider the tax position on potential borrowers when conducting due diligence and assess what impact it may have on unsecured debt or floating charge security.
Also, think about if the security position could be supplemented, or whether fixed charge security is appropriate.
They should also require their customers to deliver better and more regular information on any changes to their tax affairs and any HMRC arrears in order to understand when HMRC debt may be increasing.
Conclusion
If you want to find out anything further about this topic then please feel free to call me on 0330 236 9930, 0330 236 9938 or 07961 116321. All conversations will be in strict confidence. You can also email me vee@navigatebr.com.
This article is for information and interest only. It is not a substitute for full professional advice, which will take in to account the specific and individual circumstances. Navigate Business Recovery Limited cannot accept any responsibility for any loss arising as a result of any person or organisation acting or refraining from acting on any information.