Change in HMRC preferential status
The status of monies owed to HM Revenue & Customs (“HMRC”) in formal insolvencies changes with effect from 1 December 2020.
In all insolvencies HMRC becomes a secondary preferential creditor form 1 December 2020. This means it will be paid before floating charge creditors (typically a bank or asset based lender), suppliers, pension schemes, customers, and before deduction of the “prescribed part”.
The amounts owed by the insolvent entity in respect of the following taxes will become secondary preferential claims:
- PAYE deductions
- Employees’ National Insurance Contributions (but not employers’ NIC)
- Student loan deductions
- Construction Industry Scheme deductions
There is no time limit on when these first fell due; if it is owed to HMRC on the date of insolvency and falls into one of the categories above, it will be a preferential claim in the relevant insolvency process.
So not only will tax payments deferred during the lockdown become preferential, but it’s entirely possible that tax payable as a result of an HMRC enquiry, which might have taken several years to conclude, will also be treated the same way.
As a result, the hierarchy of payments in formal insolvency processes will look like this:
- Fixed charge holders
- Preferential creditors: employees’ arrears of wages / salary (capped at £800 per employee), employees’ holiday pay arrears and contributions to occupational pension schemes (limited to the twelve months leading to the date of insolvency in respect of employers’ contributions and four months for employees’ contributions deducted but not paid over)
- HMRC secondary preferential claims
- Floating charge holders
- Unsecured creditors
It is clear that HMRC are in a unique position, inevitably being an involuntary creditor in virtually all insolvencies, and it is difficult not to feel sympathy for the fact that as businesses are stretched financially, it is common for payments due to HMRC to be given reduced priority. So HMRC ends up acting as an unofficial and unauthorised overdraft facility, and it is arguably fair that their resulting claim has some element of priority in an insolvency.
Nonetheless, the introduction of preferential status at this particularly challenging moment may well have a number of unintended consequences.
Funders will almost certainly cut facilities as their covenants are breached. Not only will HMRC’s preferential claims rank before their floating charges but the upper limit for the prescribed part is also increasing (from £600,000 to £800,000); this will also adversely affect the return to charge holders. Reductions in working capital facilities will compound the problems faced by cash-starved businesses, already struggling with the effects of the pandemic.
In addition to existing funders reducing facility limits, it will be more difficult to obtain finance from alternative funders as asset cover will be eroded by the change in HMRC’s preferential status. This too will almost certainly drive businesses into insolvency.
We question the fairness of monies owing to HMRC from prior periods becoming preferential as soon as the legislation takes effect. If the Finance Act were modified to state that all tax payable from the financial year commencing on 6 April 2020 was preferential then there would be less scope for complaint. As it stands, HMRC has been given a huge advantage over unsecured creditors at a time when most of those creditors can ill afford the financial loss.
In summary we anticipate the consequences of HMRC’s preferential status will be:
- Reduced facilities for cash-starved businesses potentially leading to unnecessary insolvencies
- Less likelihood of obtaining alternative funding from other funders
- Reduced dividends to non-preferential creditors in all insolvency processes which will probably lead to an increase in the number of overall insolvencies
We feel there is a strong argument both for deferring the introduction of this legislation until the pandemic has been brought under control, and even then to limit the extent of HMRC’s preferential rights.
We are aware that representations have been made and continue to be made to the Treasury and we hope that common sense prevails and further breathing space is provided for struggling businesses.
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