The return of preferential creditor status for HMRC

Since our previous article, the government has confirmed its intention to give certain taxes preferential status from April 2020.

The Finance Bill 2020 is expected to give HMRC priority in the recovery of certain debts (including VAT, PAYE, Employee NICs, Construction Industry Scheme deductions - “Preferential Debts”) in insolvency proceedings by making HMRC a secondary preferential creditor. These changes are intended to come into force for insolvencies commencing after 6 April 2020.

Concerns

A summary of responses to the consultation document (published in July 2019) raised the following concerns:

• Preferential Debts would be elevated above floating charges. Floating charges provide a useful source of funding to help businesses, often in rescue situations. The new provisions would make this type of lending riskier and therefore may make it harder to rescue struggling companies;
• it is likely that floating charge facilities would be reduced in response, so some borrowers may be pushed into default; and
• there would  be reduced returns for unsecured creditors, since HMRC is typically one of the largest creditors in an insolvent liquidation. This might cause a “ripple effect” to small suppliers, and could create creditor apathy as unsecured creditors would have very little interest in the process if they see little prospect of any return.

Government response to concerns

The government has said that it does not expect the elevation of HMRC’s status in respect of Preferential Debts to have a “material impact”, as the loss to lenders will be a fraction of total lending compared to the financial benefits it would bring to HMRC. In its 2018 Budget briefing, the government suggested increased tax revenue could raise up to £185 million annually for public services.

In response to queries as to why a stage 2 (policy implementation) consultation rather than a stage 1 (policy intent) consultation was held, the government responded that it was committed to giving HMRC priority for the following reasons:

• the taxes paid by employees and customers to businesses were paid by citizens with the full expectation it would be used to fund public services - whereas under current rules these funds are distributed to creditors;
• the measure represents a balanced position in protecting taxes paid by employees and customers, but held by a company. The company should transfer these payments to the government to fund public services;
• the measure does not aim to fill a gap in HMRC’s debt collection strategy or powers; and
• the government will work with insolvency practitioners to ensure the measure is implemented in the most effective way.

Tim Carter, Co-Head of Restructuring & Insolvency and Stevens & Bolton, comments:

Despite concerns about the return of Crown preference, it is important to note that the proposed changes are not a return to pre-2002, when all tax debts enjoyed preferential status. The intention under the latest proposals is to capture those taxes which are collected by a company with the intent of such amounts being passed on to HMRC, on the basis that those funds were never truly the property of the company to use in meeting its usual payments to creditors. Additionally the government is keen to emphasise that these changes will enable more money to go towards public services and that this approach balances the interest of the taxpayers, HMRC and other creditors.

However, it remains to be seen whether these changes will reduce the availability of floating charge lending to businesses which may be struggling to obtain funds elsewhere. Key areas which might be exposed in this way are small to medium enterprises and any industries which rely heavily on lending to purchase stock or plant and machinery, such as retail or construction – sectors which are already in distress. If lenders are unwilling to lend with the reduced benefit of the floating charge, in the absence of an alternative, these changes could lead to more insolvencies.