HMRC has become secondary preferential status due to a Government proposes, in the Finance Bill 2019/20.
They are to rank after certain preferential employee claims but before the prescribed part (of up to £600,000 payable to unsecured creditors) and before floating charge creditors.
This will affect all insolvencies from 5 April 2020. There will be no limit on the age of the tax debt that will be preferential. However, interest and penalties will not be caught by the new rules.
This is known as the statutory order of priority and is set out in the Insolvency Act 1986. HMRC is usually classed as a preferential creditor in insolvencies, which means that it is repaid before unsecured creditors.
This is because HMRC is owed money for taxes that are due, such as PAYE and VAT. The preferential status of HMRC can have a significant impact on the amount of money that other creditors receive in an insolvency. In some cases, HMRC may even be repaid in full while other creditors receive nothing. For this reason, it’s important to be aware of HMRC’s position in an insolvency before making any decisions about what to do with your money.
What is HMRC Preferential Creditor Status
The Finance Act 2020 received Royal Assent in July 2020 and it provides that HMRC will be a secondary preferential creditor. Recently, the Government published the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020. These confirm that, in addition to unpaid VAT, the secondary preferential creditor will also apply in respect of the following:
- PAYE deductions;
- employee NICs;
- Construction Industry Scheme deductions; and
- student loan deductions.
What does creditor status mean in relation to company liquidation?
When a company is liquidated, its assets are sold off and the proceeds are used to pay creditors. Creditors are owed money by the company and have a legal claim on its assets. In order to receive payment, creditors must prove their debt to the liquidator. Once creditors have been paid, any remaining funds are distributed to shareholders. Creditor status gives creditors certain rights and protections under the law.
For example, creditor status gives creditors priority over shareholders when it comes to receiving payment from the company’s assets. Creditor status also gives creditors the right to vote on the liquidation process and participate in court proceedings relating to the liquidation. Consequently, creditor status is an important consideration for companies and individuals who are owed money by a company that is being liquidated.
Secondary preferential creditor status
Currently, employees are the only type of preferential creditor in cases of insolvent liquidation, but from April 2020 HMRC will join them as secondary preferential creditors. This move up the rankings further displaces unsecured creditors, and given that HMRC are usually one of the largest creditors in these situations, there are serious implications for UK businesses.
Being a secondary preferential creditor means HMRC are only preferred creditors in relation to certain types of taxes – in this case the taxes collected by a business on their behalf, such as PAYE and VAT. HMRC remain unsecured creditors for corporation tax and any other taxes owed directly by a company.
Why has HMRC’s preferential creditor status been reinstated?
The main reason for this change is to boost Treasury takings, which are reportedly set to rise by £185 million a year. This increased tax revenue will fund public services, but does it come at too high a cost for the SMEs that make up the majority of unsecured creditors in liquidation?
As a statutory body, HMRC regard themselves as involuntary creditors, and the inability to collect tax revenue owed to them is thought to be at the heart of the government’s decision.
What does the new HMRC creditor status mean
The Financial Secretary to the Treasury announced on 8 October 2019 “that taxpayers can reasonably expect that when they have successfully paid their taxes [to a business in the form of VAT or of PAYE/NI deductions], these go to fund public services”.
The draft legislation as contained in the Finance Bill confirms:
- The preferential status is limited to VAT and certain deductions namely PAYE, employee National Insurance Contributions (NIC) and Construction Industry Scheme deductions.
- There is no limitation on the age of the relevant preferred debts, albeit penalty and interest is to be excluded.
- HMRC will be the lowest category of preferential creditor.
- It will be applicable in both corporate and personal insolvency procedures.
- As a consequence of the new provisions, HMRC will rank ahead of floating charge creditors and other unsecured creditors but behind other preferred creditors and fixed security holders.
The Government could encourage HMRC to collect those taxes more efficiently and effectively. But there is no sign of it doing so. Perversely, it plans instead to penalise not the debtor business but its other creditors! From the pool of available funds in an insolvency, HMRC will benefit from a tax grab and other creditors will be left with a bigger share of the losses.
Successful business rescue demands that HMRC works proactively as the ubiquitous creditor in restructuring and insolvency situations. This preserves asset and enterprise value, maximising the prospect of business rescue and preserving jobs and future tax revenue. But it doesn’t happen.
The Government also said on 8 October 2019 that it “does not expect its plans to affect SME’s access to finance”. This is naïve. Mainstream and alternative lenders using floating charge security will see such security not only as less valuable but as having a more uncertain value. This is because of the risks of unpaid taxes (how much, they won’t know) ranking ahead of them in an insolvency.
Neither does the Government expect its plans to affect corporate insolvencies. This flies in the face of reports that some lenders are already planning to restrict lending to existing floating charge borrowers.
What impact will this have on lenders?
As any lender knows, the prospect of getting repaid is always an important consideration when extending a loan. This is especially true in the case of unsecured loans, where there is no collateral to fall back on if the borrower defaults. While returns on unsecured loans are typically low to begin with, they are set to become even lower in the wake of recent changes to HMRC’s creditor status.
Under the new rules, HMRC will take precedence over other unsecured creditors in the event of a company liquidation. This is likely to result in even fewer repayment for those who lend on an unsecured basis, as more of the company’s assets will be funneled towards repaying HMRC. As a result, lending on unsecured terms is likely to become more difficult and expensive going forward.
Conclusion
HMRC (Her Majesty’s Revenue and Customs) preferential status in the UK means that certain debts owed to HMRC, such as unpaid taxes, take priority over other unsecured debts when a company or an individual is facing financial difficulties, going through a bankruptcy process, or liquidation. This means that in situations where there are not enough assets to pay off all of the company’s creditors, HMRC’s claims will be paid before those of other unsecured creditors.
This preferential status is granted to HMRC under UK insolvency law, as taxes are considered a fundamental liability of any business or individual, and the government has an interest in ensuring that these debts are paid as a priority. This preferential status applies to unpaid taxes such as VAT, PAYE, National Insurance contributions and any other taxes.
With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.