PKF Geoffrey Martin warns that the change in HMRC preferential status from 1 December could result in increased insolvencies and calls upon the Government to defer the change
From 1 December 2020, under the provisions of the Finance Act 2020 the status of most monies owed to HM Revenue & Customs (“HMRC”) in formal insolvencies will change.
From that date, in both corporate and personal insolvencies, HMRC will become a secondary preferential creditor, meaning it will be paid in priority to floating charge creditors, suppliers, pension schemes, customers and ahead of the prescribed part, an element carved out of the funds owed to floating charge holders which is made available to unsecured creditors.
Stephen Goderski, restructuring partner at PKF Geoffrey Martin warned that the introduction of preferential status during such a challenging times will have a number of, perhaps unintended, consequences:
“Many otherwise viable businesses are struggling as a result of the pandemic. These changes will make the process of rescuing these businesses even more challenging and complex.”
“This measure, which is designed to increase the tax take, ironically could actually reduce the amount of tax collected given otherwise viable businesses are forced to close.”
Potential consequences
Funders will almost certainly cut facilities as their covenants are breached – and not only will HMRC’s preferential claims rank before their floating charges, there is also the increase in the maximum limit of the prescribed part (rising from £600,000 to £800,000) which will also adversely affect the return to charge holders. This will reduce funds available to cash-starved businesses already struggling with the effects of the pandemic.
In addition to existing funders trimming facilities, it will be more difficult to obtain finance from alternative funders as asset cover will be eroded by the change in HMRC’s preferential status. This too will almost certainly drive businesses into insolvency.
Those insolvency processes themselves may be more terminal than would presently be expected. It will be harder to secure approval of Voluntary Arrangements if the return to unsecured creditors is significantly eroded by virtue of HMRC’s preferential status. Unsecured creditors will not be disposed to agree to an arrangement where they only receive a nominal dividend over a protracted timescale; if that was a significant dividend they would more likely than not support such a proposal, as is presently the case.
It does not seem right that monies owed to HMRC from prior years should be deemed to be preferential immediately that the legislation takes effect. If the Finance Act was modified to state that all tax payable from the financial year commencing on 6 April 2020 was preferential then there would be less scope for complaint. As it stands, HMRC have been given a huge advantage over unsecured creditors at a time when most of those creditors can ill afford the financial loss.
The likely consequences of HMRC’s preferential status will therefore be:
· Reduced facilities for cash-starved businesses potentially leading to unnecessary insolvencies
· Less likelihood of obtaining alternative funding from other funders
· Less likelihood of creditors supporting processes designed to promote survival, such as Voluntary Arrangements, again forcing businesses into more terminal processes
· Reduced dividends to creditors in all insolvency processes which will probably lead to an increase in the number of overall insolvencies.
Stephen Goderski said:
“It is clear that HMRC are in a unique position, inevitably being an involuntary creditor in virtually all insolvencies, and it is difficult not to feel sympathy for the fact that as businesses are stretched financially, it is not unusual for payments due to HMRC to be given reduced priority. HMRC therefore end up acting as an unofficial and unauthorised overdraft facility and, in that respect, it is probably right that their resulting claim has some element of priority in subsequent insolvency proceedings.”
“However there is a very potent argument for the introduction of this legislation to be both deferred until the pandemic has been brought under control and even then to limit the extent of HMRC’s preferential rights.”
“Representations have been made and continue to be made to the Treasury and we hope that common sense prevails.”
Future hierarchy of payments
The hierarchy of payments in formal insolvency processes will as a result look like this:
1. Fixed charge holders
2. Preferential creditors (employees for arrears of wages and salary (capped at £800 per employee), employees for holiday pay arrears and contributions to occupational pension schemes (limited to the twelve months leading to the date of insolvency in respect of employers’ contributions and four months for employees’ contributions deducted but not paid over)
3. HMRC secondary preferential claims
4. Floating charge holders
5. Unsecured creditors
There is no timeline demarcation limiting the value of the preferential claim; if it is a deducted tax (so not Corporation Tax or Employers’ National Insurance contributions) owed to HMRC on the date of insolvency and falls into one of the categories above, it will be a preferential claim in the relevant insolvency process.
Not only will tax payments deferred as a result of the lockdown become preferential, but it is entirely possible that tax payable as a result of an enquiry which has taken, say, five years to conclude will also be treated the same way.