In any insolvency, there is a statutory hierarchy that determines how creditors are repaid, including HMRC. Since 2003, HMRC has been an ‘unsecured creditor’ – however, this is about to change with far-reaching consequences for businesses. Under the Finance Act 2020, HMRC will regain its status as a preferential creditor for insolvencies that commence on or after 1 December 2020.
Prior to 1 December 2020, the hierarchy of creditors, i.e. the order in which they get paid was as follows:
- fixed charge creditors. These are creditors whose lending to a company is secured against a definable object, for example, a mortgage;
- costs of the insolvency process, including staff wages, rent due during the process and the fees of the administrators/liquidators (as applicable);
- preferential creditors, including payments due to employees;
- ‘floating charge’ creditors. These are creditors whose lending is secured against assets that can change periodically, such as stock;
- unsecured creditors. This refers to all other creditors, including pension schemes, customers and trade creditors (including HMRC for insolvencies that commence before 1 December 2020); and
The new regime will push HMRC up to a preferential creditor and therefore outrank all floating charge creditors, unsecured creditors and shareholders. According to the new legislation, from 1 December, when a business enters insolvency, certain taxes due from an insolvent business, including VAT, PAYE Income Tax, employee National Insurance contributions, student loan deductions and industry scheme deductions temporarily held by the business, will go to fund public services rather than being distributed to other creditors.
The rules will remain unchanged for taxes owed by businesses themselves, such as Corporation Tax and employer National Insurance contributions, where HMRC will remain an unsecured creditor.
Who is affected?
HMRC remains one of the largest creditors in many insolvencies and with HMRC moving up the rankings, there will be reduced funds available for unsecured creditors, which may result in these creditors being less willing to engage in the insolvency process or offer finance to businesses on these terms.
While the measures will impact on all businesses and other organisations who are creditors involved in an insolvency, prioritising the recovery of HMRC’s tax debt could mean that secured creditors, such as asset-based lenders, in particular are affected, as they are the main holders of floating charges, which cover assets such as stock, receivables and cash in the bank.
They, along with other creditors, could receive a reduced dividend and may change their lending practices as a result of this measure, becoming more cautious in providing funding, increasing funding costs to compensate for the increased risk they carry, and reviewing how their security is structured, potentially seeking more personal guarantees from directors and family members. HMRC, on the other hand, is set to be the biggest winner.
In summary, what this will mean and the likely downsides of the return of HMRC’s preference are as follows:
- less money will likely be available for unsecured creditors of insolvent companies;
- there will be a higher level of risk for lenders, traders, and investors who will likely look for compensation by way of increased finance and personal guarantees;
- small and medium-sized enterprises may have reduced access to finance which may lead to an increase in the number of corporate insolvencies as a direct result of there being less money available to fund business growth and rescue; and
- restructuring mechanisms such as company voluntary arrangements (CVAs) will be more difficult as they require the consent of the preferential creditor and therefore give HMRC considerably more influence over insolvency processes.
This is, however, a good opportunity for businesses to review their financial arrangements, and where possible, secure director and shareholder investments and push themselves as far up the creditor chain as possible.