HMRC Preferential Status
Unsecured creditors to lose £185 million as HMRC gets preferential status
On Budget day, all eyes are typically focused on potential tax increases, the state of play of UK finances and whether there will be a rabbit pulled from the hat which shocks and surprises us all.
As such, you may be forgiven for failing to make it to page 57 of last year's Autumn Budget manifesto. This announced legislation to make HM Revenue & Customs (HMRC) a secondary preferential creditor for certain tax debts paid by employees and customers on the insolvency of a business.
The proposed change didn't make the Government’s top “24 things you need to know” summary. This was reserved for more important things, such as the announcement of a commemorative 50p Brexit coin that was to be available from spring 2019. (This didn't happen beyond a few test versions being minted because of the delay to Brexit.)
Fast forward to July 2019 when the Finance Bill 2019-20 was published. This confirmed that, despite widespread concern among the insolvency profession and lobbying from R3 (the association of Business Recovery Professionals), the Government was indeed giving HMRC preferential status with effect from 6 April 2020.
What does this mean?
In simple terms, an unsecured creditor will have less chance of receiving money back against a debt they are owed in an insolvency process. On the flip side of the commemorative Brexit coin, the Government envisages revenue recoveries will increase by £185 million through increased dividends.
This is because not all creditors rank equally in insolvency. There are two classes of creditor, secured and unsecured. For unsecured creditors, certain debts already hold a preferential status, which means they are paid before the general body of non-preferential unsecured creditors.
Currently, certain elements of claims from employees and the redundancy payments service are the only debts which typically qualify for preferential status (subject to statutory caps).
HMRC meanwhile currently ranks alongside all other unsecured creditors but this change will see it climb the ladder and sit behind the other preferential creditors.
Haven’t we been here before?
Preferential status for HMRC is not something new. In fact, when speaking with directors and creditors it is often a misconception that HMRC will be paid ahead of the general body of creditors.
This stems from the fact that HMRC did have preferential status in insolvency proceedings until 2003. The Enterprise Act 2002 abolished this preferential status, and ruled that a prescribed part of the floating charge realisations be made available to unsecured creditors.
Not only is HMRC going back to old ways, but the new law gives them even wider scope to claim debt preferentially. This is because the reincarnated version doesn't include any restrictions on the age of the debt as it once did.
The Government policy objective states that:
“Taxes paid by employees and customers do not always go to funding public services, if the business temporarily holding that money goes into insolvency before passing the tax on to HMRC. Instead, they often go towards paying off debts to other creditors.
This measure will amend insolvency legislation to move HMRC up the creditor hierarchy for the distribution of assets in the event of insolvency by making HMRC a secondary preferential creditor in respect of certain tax debts held by a business (this includes individuals and partnerships) on behalf of their customers and employees. This change will enable more of those taxes paid in good faith to fund public services as intended.”
So, while the Government does attempt to explain the rationale for the change, it still looks confusing. It's as though the Government forgot they previously gave up a similar right to ensure more funds were distributed equally among all creditors. This is seemingly something that is no longer on their agenda.
The Government believes this change will not affect the financial landscape. Perhaps the effect will not be as catastrophic as a tornado being influenced by the flapping wings of a distant butterfly, but it could have a wider impact than just the predicted loss to unsecured creditors of £185 million.
Firstly, secured lenders are going to see the value of their security weakened, specifically any monies loaned under a floating charge. This is because preferential creditors are paid in priority to debts caught under a floating charge too. While the thought of the banks losing a bit of money won’t cause too many people sleepless nights, the consequence of this could be felt by directors personally and SMEs (small and medium sized enterprises) generally.
It is not uncommon for lenders to obtain personal guarantees in addition to the security they hold over a business’s assets. If fewer assets are available for the lender under their floating charge then we could see more personal guarantees being requested and subsequently called upon, which makes it an even more daunting time to be a director. This certainly won’t encourage entrepreneurs into business.
The major banks may well reconsider their lending criteria and this could create issues for SMEs. These businesses are already facing the prospect of having to source funding from secondary lenders, who are likely to charge a higher premium. For a business which is already struggling, higher costs of finance are unlikely to help buck that trend.
Larking Gowen provides free confidential consultations for anyone who may be experiencing debt problems. Please contact a member of the Insolvency & Recovery team if you think that you may be affected by the proposed changes detailed in this article.
0330 024 0888
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