The government has opened a consultation on its plans to give HMRC preferential creditor status in company insolvency proceedings, but the proposals have not been greeted favourably by restructuring professionals
For those of you old enough to remember, the former Crown Preference rules were abolished in 2003 by virtue of the Enterprise Act 2002. We explore here what impact the government's proposed changes (which were announced in the 2018 Budget by Chancellor Philip Hammond) will have on anyone lending under a floating charge, the cost of borrowing, and also possibly the Prescribed Part*. These changes will potentially impact businesses in a big way, by changing unsecured creditor priorities and making directors liable for company taxes in certain circumstances.
In the Autumn Budget the government proposed a plan aimed at protecting tax collected on behalf of HMRC and ensuring it is actually paid to the Revenue, as follows:-
- From 6 April 2020 where a company which has collected taxes on behalf of others (such as VAT, PAYE Income Tax, employee National Insurance contributions and Construction Industry Scheme deductions) becomes insolvent without having paid those taxes to HMRC, these liabilities will take priority over other unsecured or floating charge creditors.
- Other company tax liabilities, such as corporation tax and employers NIC will not be affected.
- HMRC will remain ranked below preferential creditors.
- The Finance Bill 2019-20 will contain measures to allow HMRC to make directors and other persons involved in tax evasion or avoidance jointly and severally liable for company tax liabilities, where there is a risk that the company may deliberately enter insolvency.
- This will have effect from Royal Assent of Finance Bill 2019-20.
This represents a significant change from the current situation, where all HMRC debt ranks alongside other unsecured creditors in insolvency. The Treasury believes that up to an extra £185 million per year will reach the government.
Rationale for the proposals
According to the government, the Treasury has recorded increasing losses as a result of its change of status since 2003 and makes a moral argument for why employees’ taxes should go to the public purse when their employer becomes insolvent.
The government states: "The majority of people in the UK want to pay the right tax at the right time because they believe that it is the right thing to do and appreciate that tax revenue funds public services for everyone. HMRC provides a flexible range of support for those who would like to pay on time, but find it hard to do so."
Impact on UK businesses and lending
It appears to us that the proposals, if enshrined in law, will have a direct negative impact on a significant section of UK business, particularly SMEs and those using asset-based lending to support growth.
What impact would HMRC’s new preferential rank have on the amount lenders will advance to their customers? At a time of economic uncertainty and more strained credit options, concerns have been raised that the proposed measures will add to cash-flow pressures and thwart business recovery.
The increased risk to lenders (that HMRC will first have to confirm to the insolvency officeholder that these taxes have been paid in full before they are repaid any part of their floating secured debt until) will certainly impact on the amount any asset-based lender would be willing to lend, alternative security cover and probably push up the fees. Last year, the government approved partnerships with HSBC, Barclays, Lloyds Banking Group, Santander and Royal Bank of Scotland to allocate funds to export-focused SME companies, according to the Financial Times.
It should also be noted that these measures will not prevent businesses from using VAT and PAYE revenue to smooth short term cash-flow and will only take effect post-insolvency to give HMRC a greater priority relative to other creditors.
Restructuring professionals will be validly concerned that this will add additional work and complexity to an already rigid set of prescribed rules, and will emphasize the need for HMRC to provide proofs of debt that accurately break down the different categories of tax debt if the measure is to properly implemented. This means any asset-based lender will need to undertake a thorough review of all tax matters (going back up to 21 years), or obtain insurance to cover the risk it will not be repaid all or most of its loans, as without either of these, it will have to value its potential floating charge recovery at nil.
Whilst lenders with floating charges will be affected, the government points out that the amount by which lenders will lose out (estimated to a maximum of £185m per year by 2023/24) is minimal compared to the amount of bank lending to SMEs alone (according to the BoE bank lending data, the gross sum of new loans (excluding overdrafts) to smaller businesses reached £57bn in 2017).
Unsecured creditors, who are already vulnerable in insolvency situations, may also lose out. The government points out that it is unusual for this class of creditors to recover any of their debt from an insolvent estate but this proposal will not improve their situation, and although the government says that it will not make it any worse, this is subject to consultation.
The response thus far from various sections of industry potentially affected by these proposals, suggests that investigations have not been properly undertaken to see how many companies would fail if their facilities were withdrawn or reduced, or how tax revenue would be affected by these failures. It seems that the impact of these proposals may do little to support the health of the UK economy, and may represent a Pyrrhic victory for the government.
The Consultation – get involved!
HMRC launched a consultation on the government's proposal on 26 February 2019. The consultation deadline is 27 May 2019:
* the Prescribed Part is a ring-fenced fund for unsecured creditors, calculated as 50% of the first £10,000 of available funds, and thereafter 20% up to a maximum of £600,000. As an unsecured creditor, HMRC does currently benefit from the Prescribed Part.
If you would like to know more about the proposed changes and how this might impact your business please get in touch with our head of Commercial Dispute Resolution Dominic Offord.