HMRC prefers to benefit at whose expense?

Insolvency Bitesize - November 2018

The amount some creditors can expect to receive in a UK liquidation or administration could be set to change following the Chancellor’s proposal to give HMRC a lift-up in the waterfall of payments on insolvency.

In a controversial move, the Government announced in the October 2018 Budget that it will look to claim an extra £185m for taxes already paid by employees and customers and temporarily held by a business which enters insolvency before passing them on to HMRC. This will be achieved by granting HMRC status as a “secondary” preferential creditor from April 2020. The change will apply to Value Added Tax, Pay-As-You-Earn Income Tax, employee National Insurance contributions and Construction Industry Scheme deductions – the rules for taxes owed by the business (such as corporation tax) will remain unchanged.

As a secondary preferential creditor, HMRC will rank behind ordinary preferential creditors (mostly certain employee-related claims) but ahead of floating (not fixed) charge holders. HMRC lost its Crown Preference status over 15 years ago as part of the Enterprise Act reforms, so the proposal for its partial reintroduction is seen by many in the restructuring and insolvency community as something of a backwards step.

The Government considers that overall the change would have no material impact on lending levels given that the debts lenders would no longer recover “are a very small fraction of total lending”. However, in individual cases, HMRC’s improved status could impact on the cost of lending. A floating charge holder would see its recoveries reduced which could be particularly relevant, for example, in businesses that have large numbers of employees.

With HMRC able to recover amounts ahead of ordinary unsecured creditors, they too can expect to receive less. The Government suggests that they currently only recover 4% of debts owed on average and so “most will be unaffected”. Such creditors may not be quite as sanguine, however, on learning that what little they might otherwise receive might now be even less. Pension trustees might have to consider the impact of the proposed change as part of their ongoing covenant reviews and on their approach to restructuring negotiations.

The change should also be seen alongside the Government’s recent proposals for reform to UK corporate insolvency law in which it announced a prospective increase in the cap on the prescribed part from £600,000 to £800,000 (in line with inflation since its introduction). This would further reduce the recoveries of floating charge holders, but perhaps more significantly any benefit this increase might otherwise have given to unsecured creditors will now be reduced, since preferential creditors are paid ahead of the prescribed part.

Whether HMRC’s improved position could affect its attitude to winding-up petitions and time to pay arrangements will be watched keenly. So too will its attitude to supporting CVAs – particularly as they will not be able to affect HMRC’s preferential claim (without its consent).

For a diagram of the distribution waterfall on insolvency highlighting the proposed changes please click here.