As part of the legislative changes brought about by the Finance Act 2020, the Treasury drafted the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 (the Regulations) and laid these before parliament on 14 September 2020. View a copy of the regulations.
The primary purpose of the Regulations is to make provision for certain debts owed to Her Majesty's Revenue and Customs (HMRC) to be included in a category of preferential debt and ensure that more of the taxes paid by employees and customers will be recovered to fund public services, rather than be distributed to other creditors.
This change means that in any distribution of assets in the insolvency of a UK corporate entity, HMRC will now rank in priority to a floating charge holder, unsecured creditors and pension funds in respect of the payment of certain taxes collected or deducted by corporates including:
- Value-added tax (VAT)
- Pay-as-you-earn tax (PAYE)
- Employee national insurance contributions (NICs)
- Construction industry scheme (CIS) deductions
The Regulations will not affect taxes collected directly from a company such as employer NICs and corporation tax, which will remain unsecured claims in the respective insolvency processes.
The key date for your diaries is 1 December 2020. This date is when HMRC will revert to secondary preferential status in all insolvency processes and rank above floating charge holders and unsecured creditors.
It is also worthwhile for lenders and creditors to note that the Regulations go further than the old crown preference. Previously, only tax debts of up to one-year old enjoyed preferential status. Now, any tax debt regardless of how old it is will benefit from the new secondary preferential status, irrespective of the date that the tax debts were incurred or the date of the qualifying floating charge. This lack of a time bar means both unsecured and floating charge creditors will see their returns from insolvencies reduced.
The retrospective nature of the Regulations means floating charge lenders will have to undertake a detailed historic and ongoing review of the tax positions of the companies to whom they have lent money to check for tax debts which may now outrank their claims.
The practical effect of the changes brought by the Regulation
- Lenders and unsecured creditors face the possibility of seeing reduced returns if a company becomes insolvent, they may become less willing to lend and this is a blow to companies already in financial distress in an already difficult market. This also may see an increase in knock-on insolvencies with more businesses failing due to the reduced returns.
- The extent of the reduced returns may be exacerbated to the extent of any deferred VAT payments due between March and June 2020 which could be deferred to March 2021, which will now take on priority status.
- Increasingly lenders may prefer the security of a fixed charge or personal guarantees from directors or their family members wherever possible to provide them with comfort. For corporates, this means reduced liquidity and available funds. For directors and their family members, this means more exposure to personal liability.
- Lenders are likely to want to review the company's tax position of a borrower prior to the advance of funds and on an ongoing basis. Borrowers will have to be more transparent in divulging their tax position to a lender and keeping accurate accounts of their tax liabilities. This may be a positive as it will ensure all parties are more aware of their exposure and be able to protect their respective position well in advance.
- Asset-based lenders who use security on floating charged assets to provide working capital will suffer particular hardship in already difficult trading conditions. Floating charges will no longer provide a useful source of funding to help businesses in rescue situations, with HMRC debts likely to use up any realisable funds.
Ultimately, the impact is likely to mean less cash for businesses, at a time when businesses desperately need cash to get back on their feet and help boost the UK economy. The Regulations will lead to a reluctance in lenders providing corporates with funding, and many lenders will be concerned about the existing loans given the lack of time bar to the Regulations.
It may force some lenders to be proactive and take action in advance of the 1 December deadline where their debtor is in distress or insolvency, by accelerating those companies into a process before the crown preference comes into effect.
One benefit may be that there is a more transparency and dialogue between a lender and the borrower. Lenders may consider requiring borrowers to make certain disclosures about the tax position of the borrower, provide financial updates during the duration of the loan, and allow the lender access to the relevant company records.
This is likely to increase the responsibility of the directors of borrowers, who will now more than ever need to have their finger on the pulse of the financial health of their company and an understanding of the company's tax position. A director may now be more likely to seek professional assistance sooner rather than later and ensure company's tax liabilities do not increase to an unmanageable level.
At a time when business is still suffering the impacts of the COVID-19 pandemic and access to finance is more crucial than ever, re-introducing crown preference is likely to impede the recovery of many viable companies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.