HM Revenue & Customs – A New Class Of Preferential Creditor
As I touched upon in my last article available here, preferential creditors are presently employees for wages up to £800 and unpaid holiday pay, contributions to occupational pension schemes, and more rarely coal and steel production levies. In a formal insolvency procedure these debts enjoy a higher-ranking status, getting paid ahead of qualifying floating charge holders and unsecured creditors.
Historically, HM Revenue & Customs (“HMRC”) had enjoyed a higher, preferential ranking in the statutory order of payment for insolvent estates for certain VAT, PAYE, CIS and NICs debts. This status was abolished in the Enterprise Act 2002, when all HMRC debt was re-categorised as unsecured in order to provide a level playing field for business and promote an entrepreneurial culture in the UK. However, in the recent Budget, Chancellor Philip Hammond has reintroduced ‘preferential’ status for HMRC in insolvency proceedings.
This raising of HMRC’s priority status is due to start in April 2020 and will allow HMRC to jump the queue of other unsecured creditors such as most trade suppliers, landlords and non-preferential employee entitlements. The Budget stated that: “This reform will only apply to taxes collected and held by businesses on behalf of other taxpayers (VAT, PAYE Income Tax, employee NICs, and Construction Industry Scheme deductions). The rules will remain unchanged for taxes owed by businesses themselves, such as Corporation Tax and employer NICs.” The ranking will constitute a new secondary form of preferential status, falling behind the current preferential creditors but ahead of the general body of unsecured creditors. The move is designed to ensure “that an extra £185m in taxes already paid each year reaches the government.”
THE NEW ORDER OF PRIORITY
The Order of Priority by which remaining assets/funds are distributed, after payment of the costs and expenses of the procedure, will from April 2020 be as follows:
- Liabilities to fixed charge creditors holding security over a specified asset or asset class;
- Liabilities to existing preferential creditors such as employee wages (to £800) and holiday pay;
- Liabilities to HMRC for VAT, PAYE, NICs, CIS;
- Liabilities to floating charge holders holding security over a fund of changing assets;
- Liabilities to all other unsecured creditors such as trade suppliers, landlords, pension funds, and other employee entitlements;
- Liabilities to shareholders such as unpaid cumulative preference dividends
Company Voluntary Arrangements (“CVA”) – currently CVAs are a powerful rescue tool to bind unsecured creditors and allow a viable business to continue to trade. Preferential creditors, however, cannot be bound by a CVA unless they acquiesce to be so bound. Accordingly, any attempt to deal with historic debt, which will invariably include HMRC liabilities, by way of a CVA will no longer be viable unless HMRC agree effectively giving them a veto. This will result in all CVA proposals having to offer HMRC 100p in the £ on the preferential elements of their claim, to be paid in priority to any unsecured dividend taking place, which will severely negatively affect the viability and attractiveness of this business rescue procedure.
Floating charge and unsecured creditors – HMRC gaining preferential status will push both types of creditors further down the pecking order resulting in lower returns.
Lending – Whilst the government and Office for Budget Responsibility have both predicted that this measure will have no effect on the UK lending market, this seems to be a debateable assumption. With lower floating charge realisations resulting in less valuable security, banks will surely look to reassess their lending criteria, review their security, make changes to their borrowing terms and take a more proactive approach to any sign of default. Financial institutions will understandably want to see their returns reflecting the additional risk they will face, thereby increasing the cost of borrowing for small businesses.
Prescribed Part – is legislation that allows unsecured creditors to benefit from a fund carved out from net property contained within a floating charge, which could likely disappear completely now that net floating charge property will be significantly diminished by its lower ranking status.
Period of application – HMRC’s historic preferential status only applied to PAYE for the preceding 12 months and VAT for the preceding 6 months. There has been no confirmation as whether this new preferential status will be similarly time-bound or if in fact it will apply to all amounts falling due, notwithstanding when they were incurred.
Penalties – there has been no confirmation as to whether the new status will apply to penalties levied against businesses for the taxes included, which if so will only further lower potential returns to other creditors.
There are serious questions as to how this change in policy will be managed by HMRC and the knock-on effects on lending, small business owners and business recovery in general. Initially, this feels somewhat like a retrograde step in the government’s stated aim to improve the UK’s position in the World Bank’s annual ‘Doing Business Report’ which scores national insolvency frameworks on criteria including recovery rate for creditors, the time taken to resolve insolvencies, cost of proceedings and the number of business rescues. Undoubtedly it will result in lower returns to floating charge holders and unsecured creditors. To quote the Institute of Chartered Accountants in England & Wales: “It will amount to a tax on creditors, including small businesses, pension funds, suppliers, and lenders, and reverses a status quo that has been encouraging business rescue since 2002.”