The announcement by Chancellor Philip Hammond that HM Revenue and Customs (HMRC) would revert to secondary preferential creditor status for taxes collected on its behalf in all insolvency situations will likely have a significant negative impact on lending to UK Plc, according to analysis by Duff & Phelps.

In a return to the pre-Enterprise Act 2002 era, the Chancellor announced in the 2018 Autumn Budget that HMRC’s preferential creditor status in insolvencies will be restored from 6 April 2020 onwards. HMRC’s preferential creditor status was abolished as part of the Enterprise Act 2002, a measure that was part of a number of reforms introduced by the then-Labour Government to encourage business rescue and to make the insolvency process fairer on unsecured creditors.

Michael Bills, Managing Director, Restructuring Advisory, Duff & Phelps, said “Under existing legislation for insolvency processes, HMRC’s claims for unpaid taxes are unsecured and rank below floating charge holders and preferential creditors for the proceeds from the sale of floating charge assets such as stock, non-assigned debtors and certain plant and machinery.”

“This ranking has allowed lenders to businesses, in particular asset-based lenders or ABLs, to rely more readily on floating charge assets for security. This ultimately enables ABLs to offer higher levels of funding in support of a borrower’s growth or turnaround, either via higher advance rates from invoice finance facilities, inventory facilities linked to changing stock levels and, in some cases, ‘cash flow’ loans. It has also afforded ABLs greater flexibility with respect to reserves and short-term overpayments when the borrower needs additional support.”

As part of the proposed legislative changes, the Chancellor announced that HMRC would revert to secondary preferential status for those taxes collected on its behalf, which are limited to:

  • Value Added Tax (VAT)
  • Pay-as-you-earn tax (PAYE)
  • Employee National Insurance Contributions (NICs)
  • Construction Industry Scheme (CIS) Deductions

The proposed legislation will not impact taxes collected by HMRC directly from a company such as Employer NICs and Corporation Tax, which will remain as unsecured claims in insolvency processes.

Allan Graham, Managing Director, Restructuring Advisory, Duff & Phelps said “These changes will deplete the security pool available to lenders that are reliant upon floating charges to collateralise their lending facilities. Where an ABL is particularly reliant upon floating charge assets to secure facilities it is currently providing to a borrower, the ABL may be forced to reduce or even withdraw existing facilities.”

“The move is likely to have a significant impact on the funds recovered from insolvency processes by both secured floating charge creditors and unsecured creditors and, by extension, business rescues and the availability of funding as well as the pricing of that funding.”

‘The Government is currently in consultation regarding the proposed legislation which closes on 27 May 2019 and, whilst many in the ABL community and restructuring profession are lobbying for the repeal of these proposed changes, the Government is committed to implementing the legislation from April 2020.”

“The Government anticipates that this measure may achieve additional recoveries for HMRC from insolvency processes after April 2020 of approximately £185m per annum and that the proposals will not “lead to any particular difficulties”. However, in our view, it does not appear that sufficient consideration has been given to the squeeze on floating charge related lending facilities, and therefore the overall impact upon business rescue and funding.”

“This proposal has appeared at the same time as the Insolvency Service proposing an increase in the ‘prescribed part’ – money which would otherwise be paid to floating charge holders, but which is ring-fenced for unsecured creditors – from a maximum of £600,000 to £800,000. Whether this move was coordinated or not, floating charge holders will feel squeezed.”

Bills concludes, “If your business is currently funded by any form of ABL facility, and especially if you benefit from either a high invoice finance advance rate (85% plus), stock facility or cash flow loan, we recommend undertaking an urgent review of your existing facilities.”