HMRC regains its status as a preferential creditor
For almost 20 years, HMRC has been an unsecured non-preferential creditor in respect of sums owing to it. But the Finance Act 2020 confirmed that HMRC would regain its status as a preferential creditor in insolvency proceedings where the relevant date is on or after 1st December 2020.
Previously, employees were the only preferential creditors in insolvency. Now, HMRC is a secondary preferential creditor payable behind employees for outstanding VAT and deductions from employees’ wages including PAYE, Employee NI, student loans and Construction Industry Scheme deductions.
The result of this is that when a company goes into a company voluntary arrangement, administration or liquidation, HMRC has moved up the rankings when it comes to who gets paid out first. Specifically, HMRC will be paid ahead of floating charge and unsecured creditors.
The government says these changes have been made to allow HMRC to collect more tax from insolvent companies and individuals. Estimates suggest it will boost Treasury income by around £185 million a year.
The impact this will have on lending, dividends to unsecured creditors, the rescue culture, the insolvency process and businesses is likely to be substantial. Here are our thoughts on how the change will impact those affected.
Impact on Lending
The government says it does not expect the change to have a material impact on lending. Despite this, the change means that debenture holders are less likely to be repaid in the event of insolvency. Accordingly, they are likely to demand more fixed charge security, more third-party security and more guarantees. Given that these are, in many cases, already being taken, the net result will likely be fewer and smaller loans. This, in turn, may impact on growth and employment and may contribute to an increase in the number of business failures and redundancies.
Impact on Unsecured Creditors
HMRC are often one of the largest creditors in an insolvency. The change in their status means that HMRC will receive funds that would previously have been shared equally among unsecured creditors. Prioritising the recovery of HMRC’s debt will reduce, and in many cases, wipe out the dividend to unsecured creditors. As a consequence, this is likely to increase the cost of credit insurance and reduce the trade credit available from suppliers. With many businesses already struggling to survive as a result of Covid lockdown measures, if suppliers stop supporting struggling businesses and are unwilling to extent credit, even more businesses could be heading towards insolvency.
Impact on Rescue Culture
Consensual restructuring is unlikely to be affected since this relies on reaching Time to Pay agreements with HMRC, albeit where HMRC are paid in full.
However, company voluntary arrangements (CVAs) as a rescue procedure are likely to be severely impacted. Previously, trade creditors as unsecured creditors in CVAs were paid the same percentage dividend as HMRC. Now, in a CVA HMRC is required to be paid 100% before there is any payment made to trade and other unsecured creditors. Given that CVAs are intended to pay as much as possible to creditors, the 100% payment to HMRC means there will be considerably less money available for those creditors whose support is needed for a CVA to be approved. It is therefore likely that fewer CVAs will be approved and as a consequence fewer companies will be saved from liquidation.
Impact on Insolvency Practitioners
When the proposed Bill was put out for public consultation last year it received much criticism from organisations like the Law Society, the Credit Protection Association and R3, the insolvency trade body, whose president described the Bill as “shooting first and asking questions later”. He said: “This increases the risks of trading, lending and investing, and could harm access to finance, especially for SMEs. This means less money is available to fund business growth and business rescue, and, in the long term, could mean less tax income for HMRC from rescued or growing businesses. It’s a self-defeating policy.”
But nevertheless, the government pressed on and those in the turnaround and restructuring industry have to adapt. Now that the change has come into effect, insolvency practitioners and solicitors have to manage the expectations of those clients on whose behalf petitions are issued. While not all debts owed to HMRC have preferential status, those debts that are preferential, unlike pre-Enterprise Act 2002, will not be time barred resulting in further reduced funds being available to pay dividends to unsecured creditors.
Whilst issuing petitions has never been a guarantee of clients getting their money back, under the new legislation the dividend prospects to floating charge and unsecured creditors are very likely to be diluted and they must be prepared for this.
