The Government has announced that it is pushing ahead with proposals to prioritise the repayment of some tax debts in insolvencies from April 2020. The extra money which will be repaid to HMRC under these proposals will come out of funds which would otherwise have been paid to creditors including pension schemes, trade creditors, lenders, and employees.

The consultation on the Government’s proposals closed in May 2019. Following this consultation, the Government is now proposing that:

  • In insolvency procedures starting in or after April 2020, certain debts owed to HMRC, including PAYE, employee NICs, and VAT, will be repaid in priority to debts owed to floating charge holders and unsecured creditors. Currently, all HMRC debt is unsecured.
  • Following a consultation, the Government has decided that tax penalties will not form part of HMRC’s preferential claim. However, the Government has rejected widespread feedback that there should be a cap on the age of tax debts eligible for preferential status and that the changes should only apply to tax debts arising and floating charges created after 6 April 2020

The business community and the insolvency and restructuring profession have repeatedly warned the Government that its proposals are a threat to access to finance and a threat to business rescue.

Commenting on the proposals, R3 President Duncan Swift said “While the Government has removed one damaging part of its original proposals – unproven tax penalty debts won’t be included in HMRC’s new priority claims – this is very much a case of the Government shooting first and asking questions later. That’s not a recipe for good policy.”

“The Government should have gone much further in cutting back the scope of its proposals. Unlike the earlier, pre-2003 version of this policy, the size of the Government’s priority claim is uncapped, creating significant uncertainty in insolvencies for lenders, businesses, and others. A cap on the age of tax debt eligible for priority status would have been an obvious way to limit the downsides of the proposal. Ensuring that tax debts don’t take priority over pre-existing floating charges would have made these proposals much fairer, too.”

“The downsides of this policy are plain to see. More money back for HMRC after an insolvency means less money back for everyone else. This increases the risks of trading, lending and investing, and could harm access to finance, especially for SMEs. This means less money is available to fund business growth and business rescue, and, in the long term, could mean less tax income for HMRC from rescued or growing businesses. It’s a self-defeating policy.”

“The policy really doesn’t seem worth it. The Government is expecting a relatively small tax boost – under £195m a year, at most – and seems prepared to accept damage to access to finance and increased costs in insolvency to get it. The wider costs of this policy will outweigh the benefits. The Government must think again.”

Background to the Government’s Proposals

At the October 2018 Budget, the Chancellor announced out of the blue that he plans to “make HMRC a preferred creditor in business insolvencies” from April 2020. The Government’s plans amount to a Treasury cash grab with serious implications for UK business rescue and access to finance, and will increase the impact of corporate insolvencies on pension schemes, employees, consumers, and the wider business community.

What’s being proposed?

In insolvency procedures, creditors are repaid according to a strict, statutory ‘order of priority’ (see below). Because an insolvent company is unlikely to be able to repay all its debts, the lower a creditor is down the hierarchy, the less of their money – if anything – they are likely to see back. The Government’s plan is to move some HMRC debts ‘up’ the hierarchy, moving them above debts owed to suppliers, consumers, pension schemes, and employees, as well as common types of lending debts. Affected tax debts include PAYE, employee NICs, and VAT. Other tax debts, such as Corporation tax or employer NICs, will remain an unsecured debt. The changes will take effect from 6 April 2020.

This move will partly reverse the Enterprise Act 2002 which, in order to support an enterprise culture in the UK, ended HMRC’s original preferential status – known as Crown Preference – and established HMRC as an unsecured creditor.

Unlike the original ‘Crown Preference’, tax debts will qualify for preferential status regardless of when they arose. Previously, only tax debts arising up to 12 months prior to insolvency benefitted from preferential status. The proposal is ‘retrospective’: while it will apply to insolvencies starting after 6 April 2020, any tax debts and penalties from before this date will have preferential status, while floating charges created before this date will be outranked by HMRC’s claim.

What effect will it have on business rescue and other creditors?

Impact on pensions, suppliers, customers and lenders: The creditors most affected by the changes are those leapfrogged by HMRC: ‘floating charge’ creditors (who lend against a changing asset, such as stock) and unsecured creditors (such as the company pension scheme, some employee claims, and the company’s suppliers or customers – including small businesses and consumers). The extra money HMRC gets as part of the proposed reform will be coming from what would otherwise be repaid to these other creditors. The lack of a time ‘cap’ for the new ‘Crown Preference’ means unsecured and floating charge creditors could get even less back in insolvencies than they did before the Enterprise Act 2002.

The impact on business rescue and funding: This squeeze on ‘floating charge’ lenders could have a big impact on business rescue and funding. Floating charge lending is a very common form of business finance and some business sectors, such as retail, are particularly dependent on floating charge lending for financing stock.

With floating charge lenders facing the possibility of not seeing their money back if a company becomes insolvent, they will be less willing to lend, particularly to those companies already in financial distress (but who may be in a position to turn themselves around with fresh funding). Floating charge lending will, in effect, become as risky for finance providers as unsecured lending.

Because the proposal is retrospective, lenders may have to take out insurance on existing floating charge loans, while they will have to review every borrower’s books to check for unpaid taxes which may pose a risk to their capital. The costs of this may be passed onto borrowers.

The increase to the cost and risk of lending will make it harder for distressed businesses to restructure, and will make it harder for healthy businesses to grow.

What effect will it have on the insolvency process?

As a preferential creditor, HMRC will have additional responsibilities in insolvency procedures, creating the risk of a bottleneck: HMRC’s lack of engagement can already cause delays in insolvency procedures; more tasks for HMRC may mean more delays, exacerbating the impact of the proposal on other creditors.