In the 2018 Budget, the Government proposed the introduction of legislation to make HMRC a secondary preferential creditor for certain categories of tax debts. The proposed changes are controversial in that they would, to some extent, reverse the changes implemented in 2003 by the Enterprise Act 2002 when Crown preference was removed. The stated aim of the change is to ensure that when a business enters insolvency “more of the taxes paid in good faith by its employees and customers should go to fund public services as intended, rather than being distributed to other creditors”.
On 26 February 2019, HMRC issued a consultation on the proposed change in the priority of creditors. Any changes implemented following the closing date will come into effect in April 2020 and apply to any insolvencies starting after 6 April 2020.
What is likely to change?
The current priority of creditors is as follows:
1. secured creditors with a fixed charge;
2. insolvency practitioners’ fees and expenses;
3. preferential creditors;
4. ‘prescribed part’ creditors;
5. secured creditors with a floating charge;
6. unsecured creditors; and
7. shareholders.
The new measures would cause HMRC to be elevated from its current status as an unsecured creditor to take priority over floating charge holders and unsecured creditors, but only for taxes actually held by a business on behalf of their customers and employees. The change would apply to PAYE, VAT, employee NICs and Construction Industry Scheme Deductions (plus any interest or penalties due on these payments) received by the company prior to entering insolvency, but which had not been passed on to HMRC. However, HMRC will still rank as an unsecured creditor for taxes directly related to the business (e.g. corporation tax and employer NICs).
Although the new priority rules will apply to insolvencies starting after 6 April 2020, debts of any age will be caught by the new priority status.
What is the likely impact?
By granting elevated status to certain of HMRC’s claims, the concern is that returns to unsecured creditors will be even further diminished. To off-set this risk in part, there is a separate proposal for the ‘Prescribed Part’ (which is pool of monies ring-fenced from floating charge realisations for the benefit of unsecured creditors) to increase from (a maximum pool of) £600,000 to £800,000. In most cases, unsecured creditors only currently recover approximately 4% of debts owed to them in any event and so HMRC argues that, in reality, any effect on their recovery by the current proposal will be de minimis.
The combined impact of (a) HMRC’s elevated creditor status and (b) the increase in the ‘Prescribed Part’ is that qualifying floating charge holders will inevitably feel the pain more acutely on business insolvency: they will both now rank behind HMRC (to some extent) and receive a lesser return from their security. It is quite possible that this will make lenders less willing to offer finance to smaller businesses, who have little in the way of fixed assets, and could therefore have a prejudicial impact on their ability to obtain funding. While on the one hand, HMRC anticipates that the proposed change is unlikely to have any material impact on lending, on the other it estimates that its new partial priority will recover a maximum yield of £185 million a year for the Government coffers. Given that this very significant pool of funds will no longer be recoverable by floating charge holders, it does seem at least probable that the lending criteria to smaller businesses might become tougher.
Further, given the increased yield, HMRC may be more likely to pursue a winding up petition against a company for its unpaid tax bills (as opposed to agreeing a time to pay arrangement), as a means to recover its debts.
Conclusion
The outcome to the consultation is awaited and time will tell how much impact the responses are likely to have. However, the proposal is not popular with many seeing it as a move backwards which is likely to have only negative effects on small businesses.
A copy of the Consultation Paper can be found at:
Responses to the Consultation should be sent to insolvency.protectingtaxes@hmrc.gsi.gov.uk
Tim Carter