HMRC Preferential Status reborn after 18 years

HMRC have jumped ahead of other creditors in Insolvency Proceedings with new Preferential Status for PAYE, VAT etc

Background

From the 1 December 2020, HMRC regained its preferential status as a creditor in insolvency proceedings, which it gave up back in September 2003, but with its return there have been some subtle changes to the historical benefits HMRC had with having preferential status which strengthens HMRC’s position at the expense of other creditors.

The change in status applies to insolvency proceedings commencing on or after 1 December 2020.

Rationale

HMRC has long considered itself an ‘involuntary’ creditor, particularly in respect of taxes that a business is collecting on its behalf, such as VAT, PAYE, Employee’s NIC and CIS. HMRC’s reasoning in this regard is that the business is acting as their agent in collecting or deducting the taxes on their behalf, having received the amount due from customers or deducted from employees to be held on a temporary basis before being paid across to HMRC and not to be used to fund other business costs or settle other creditors.

As a result of the abolishment of HMRC’s preferential status in 2003, HMRC’s recoveries from insolvent businesses have reduced significantly and they see the reinstatement of preferential status as way to counter this.

The consequences in insolvencies for unsecured creditors

The impact of the change to HMRC’s status is in how it now effects the order of priority when returning funds to creditors from an insolvency procedure and the reduced amount that those creditors may receive.

The new order in which creditors and costs of insolvency are paid (simplified)

Proceeds of fixed charge assets paid to fixed charge holders.

A fixed charge is attached to an identifiable asset such as freehold property and provides the lender with security to receive the funds realised upon the sale of the charged asset to repay any debt remaining due.

Fees and expenses of insolvency proceedings

The fees and expenses incurred by an Insolvency Practitioner in dealing with an insolvency process such as a liquidation or administration are, after agreement, deductible from the funds created from realising the non-fixed charged assets of the company.

Preferential debts:

Certain creditors are given preferential status which means they receive payment in full from funds before other creditors receive any payment towards their debt.

With the reintroduction of HMRC preferential status, there are now two classes of Preferential Creditors, namely ‘First’ Preferential and ‘Secondary’ Preferential. HMRC’s reintroduction as a preferential creditor is as a Secondary Preferential creditor which means they would not receive any funds against any amounts owed until such time as the ‘First’ Preferential creditors have been paid in full.

‘First’ Preferential creditors consist of:

  • Certain pension contributions
  • Employees arrears of wages capped at £800 per employee plus accrued holiday pay
  • Amounts owed to the Financial Services Compensation Scheme
  • Deposits covered by the Financial Services Compensation Scheme

Secondary preferential creditors, for unlimited amounts and without time limits, consist of:

  • VAT
  • PAYE
  • Employee’s NIC
  • CIS
  • Student loans

Floating charge holders

A floating charge is security over assets that change in quantity and value on a regular basis, such as stock, debtors or the cash held in the company’s bank account.

A holder of a floating charge would receive any surplus funds after ‘First’ and ‘Secondary’ Preferential creditors have been paid in full.

Unsecured creditor

An unsecured creditor is an individual or company that provides products, services, or lends money without obtaining any form of security, such as suppliers, landlords and business rates.

HMRC Preferential status

Outcome for creditors

The change in HMRC’s preferential status has a particularly relevant effect now, following the Government support measures that were introduced in 2020 due to the Covid-19 pandemic. One of the measures introduced to help businesses with their cash flow during the crisis was the VAT Deferral Scheme, of which over half a million businesses signed up, allowing them to defer VAT payments that were due between March and June 2020. Further assistance has been provided recently by allowing the amounts deferred in that period to now be paid by way of smaller monthly instalments under the Vat Deferral New Payment Scheme.

Many businesses will now owe significantly more to HMRC than they would have done without the ability to defer payments and with the introduction of HMRC’s econdary preferential status from 1 December 2020, HMRC will now benefit from being in an improved position as a creditor, whilst floating charge holders and unsecured creditors will see a reduction in any return on their debts.

Other considerations

  • The reintroduction will reduce returns to floating charge and unsecured creditors.
  • As a result, lenders may be unwilling to advance funds under a floating charge, or the cost of any lending may increase. Additional personal guarantees or security may be sought to protect the lender.
  • Lenders may reduce or withdraw lending facilities due to the significant erosion of the value of their floating charge security due to the introduction of HMRC preferential status which could lead to the eventual insolvency of a business.
  • Increased exposure for claims against directors under personal guarantees given to lenders with floating charges.
  • Options available to businesses with significant HMRC preferential debt may be limited and the ability for businesses to propose Voluntary Arrangements will be reduced with the need to settle all preferential creditors in full before unsecured creditors receive any return on their debts.
  • HMRC will have more influence in insolvency proceedings and their interests may not be aligned with other creditors, whilst at the same time they may hold the voting power to control the process.
  • HMRC may in the future take a more aggressive approach to pursuing arrears because their new preferential status may provide them with a greater prospect of recovery.
  • Penalties and interest will not form part of HMRC’s preferential claim.
  • HMRC’s preferential status will apply over all floating charges, whether created before or after 1 December 2020.

AUTHOR: Mike Fortune (Director)