HMRC to have Preferential Creditor Status?

Even though the Government proposal has been previously covered by other posts, we feel giving you more update will be useful now that the proposed changes to Crown Preference are under formal consultation by HMRC.

The proposed changes were made known to the public in last October’s Budget; it was revealed then by the Chancellor that HMRC is to become a ‘secondary preferential creditor’ in corporate insolvencies.

Therefore, starting from April 6, 2020, the HMRC could receive repayment for certain tax debts owed by insolvent companies (NICs, PAYE, and VAT included) ahead of debts owed to unsecured creditors and floating charge holders.

This is of great concern. Successive Governments have made attempts to promote a business rescue-work culture which has been improved by efforts of the current Government to support the insolvency framework in the United Kingdom. If these proposed changes should happen, all of this will be undermined.

What’s happening?

The main information of the proposed plan by the Government is as follows: When an organization enters an insolvency procedure, debt repayment by the company is done following a statutory hierarchy.

The higher up the order, the creditor is more likely to receive at least some repayment of its debts, and vice versa (the creditor is less likely to receive payment the lower down the order). The plan of the Government is to shift HMRC debts close to the top of the order from the bottom.

This is a move of restoration of something referred to as ‘Crown Preference.’ The Government scrapped crown preference in 2003 when it took a stand that it needed more funds from insolvencies to return to businesses, consumers and lenders.

There is more to the new proposal compared to the old crown preference; before, only a year-old (or nearly a year old) tax debts are entitled to preferential status. And now, regardless of the duration, any tax debt will be bumped up the order.

Impact on finance access

Access to finance in the UK will be affected significantly and negatively by these plans. In some business areas in the UK, floating charge funding is a very common type of finance where the money is lent against a changing asset such as stock.

However, these creditors will not be a high priority under this proposal. Lenders will be less interested in lending since they are less likely to get their money back once the company becomes insolvent; this news is bad for all types of businesses, including business in need of funds to perform a restructure or those in need of funds to support growth.

The retrospective nature of this proposal, at a practical level, means floating charge lenders needs to undertake a comprehensive historical and ongoing review of the company’s tax positions to who they borrowed money to check for tax debts which may not outrank their claims.

Since task liabilities will increase the cost of obtaining floating charge financing, lenders may also want to insure themselves against it; this is another disadvantage to businesses that rely on this form of finance when they make efforts to develop a recovery plan.

Impact on HMRC and unsecured creditors

Unsecured creditors such as pension scheme of the company, claims by some employee, as well as the company’s customers or suppliers will be affected by moving HMRC up the priority list. The extra funds received by HMRC as part of the proposed reform will come from what would otherwise be repaid to these creditors.

The new ‘crown preference’ lacks a time ‘cap,’ the implication is that both unsecured and floating charge creditors could receive a lesser amount in insolvencies than they did before 2003.

Another major problem at hand is that as a preferential creditor, HMRC will have to play more active roles in procedures regarding insolvency. This requires HMRC to vote on approving important areas of the process creating a bottleneck risk – an enhanced risk due to delays caused by HMRC’s current approach.

Alternative options

The damage this proposal will create on the long run greatly overshadows the benefits expected by the Treasury. The Government has to shun its plans of restoring ‘crown preference,’ by doing so, prevent possible damages to supply chains, pension schemes, consumers and business lending as a result of this proposal.

If this option is not possible, then it’s crucial the government scale back the scope of this proposal. A simple way to go about this would be to reduce the number of agencies required by HMRC in insolvency procedures, restrict the age of tax debts affected, and cap the size of HMRC’s preferential claim.

In addition to simplifying this proposal plans, these recommendations would also minimize the consequences for parties it will affect.

Finally, if HMRC gains more active engagement in insolvency procedures than it does at the moment, the Government would see a better return from insolvencies.

This solution is much better than jumping the creditor queue in insolvencies all in the name of generating income for the Treasury, while the stakeholders, businesses, and all parties involved in business rescue suffer tremendous risks.