From 1 December 2020, HM Revenue & Customs will become a secondary preferential creditor in corporate insolvencies.
The government announced at the 2018 Budget that it would be seeking to protect “taxes that are temporarily held by insolvent business”, with legislation enacted in the 2020 finance bill, to give preferential status to certain debts due to HMRC in the event of Insolvency. “Temporarily held taxes” arise during the normal course of trading. Certain taxes due from employees and customers are withheld by the business and then paid over to HMRC in lump sums, periodically, with the business acting as an intermediary.
One such example is Income Tax and National Insurance Contributions owed by individual employees, often deducted via the company PAYE scheme. An employee will first pay taxes to their employer through a deduction from wages and salaries and then later the employer passes all of their employees’ deductions to HMRC, on a monthly basis. The scheme works well in reducing the burden of administration on individual employees; however, when an employer becomes insolvent it may be holding funds due to HMRC at the time of insolvency. These funds may then be used to pay other creditors rather than HMRC as intended.
From the 1 December 2020, certain HMRC debts will now rank as a secondary preferential creditor. An example of the debts are :-
- VAT (Value Added Tax)
- PAYE (Pay As You Earn ) Income Tax
- Employee National Insurance Contributions (NICs)
- Student Loan deductions
- Construction Industry Scheme Deductions.
(NOTE:- Corporation Tax, Employer NICs and Climate Change Levy IS NOT INCLUDED)
This applies to all such debts irrespective of when they arose. It is not limited to debts arising on or after 1 December 2020.
HMRC secondary preferential status means that in insolvency it now ranks ahead of the claims of a floating charge holder (typical security held by a lender) and unsecured creditors. The Crown’s new preferential status will have a significant impact on floating charge holders. The erosion in value of the floating charge may, therefore, mean lenders are less willing to advance new loans or roll over existing debts, without the need for added security and increased costs.
Time to pay arrangements have been common during the pandemic as many businesses, having taken advantage of the option to defer VAT payments or fallen behind with payments as a result of the pandemic, have greater than normal HMRC liabilities, and may be sizeable in some cases. It remains to be seen what effect it will have on HMRC’s approach to struggling companies. On one hand, they may be more willing to enter time to pay arrangements, where there is a greater likelihood of a return to them in the event of insolvency. On the flip side they may become more trigger happy when issuing demands and wind up petitions.
Where directors have granted personal guarantees in the past to lenders in addition to floating security granted over company assets, the introduction of the secondary preferential status may mean lenders are more likely to suffer a shortfall in an insolvency which in turn, increases the likelihood of directors being pursued under their personal guarantees for any deficit.
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If you would like further information regarding the HM Revenue & Customs new preferential status or any further advice regarding business recovery please contact our Insolvency & Business Recovery Director, Mark Botwood.
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