HMRC to be reinstated as a secondary preferential creditor from 2020

This article was co-authored by Alexandra Miller, Trainee Solicitor, London.

Nestled amongst a raft of incentives to tackle tax evasion in Philip Hammond’s third Budget Report, was the announcement that Her Majesty’s Revenue and Customs (HMRC) will once more become a secondary preferential creditor in businesses insolvencies from 2020. The decision has been met with much scepticism, with the chief concerns being that ordinary suppliers and SMEs, who will be pushed down the pecking order, will be left out of pocket and the wider concern that it will deter banks from lending to companies.

Historical position

These concerns were among the considerations which led to the abolition of HMRC’s preferential status in insolvencies. The Insolvency Act 1986, had afforded HMRC preferential status in respect of PAYE, CIS and NICs, arising in the year prior to insolvency, and VAT arising in the six months prior to the insolvency. This position was paralleled only by particular debts to employees of certain businesses, and ranked ahead of the interests of floating charge securities and unsecured creditors, which safeguarded a substantial recovery for HMRC in business insolvencies with little fuss.

Galvanised, however, by a desire to secure higher dividends for trade creditors and a hope that it would encourage HMRC to take a more active role in business rescue, the government, by virtue of the Enterprise Act 2002, removed HMRC as preferential creditor, leaving them equal to unsecured creditors. This simultaneously reinforced the UK’s framework for salvaging floundering businesses and, at a time when businesses were borrowing an increasing amount, significantly reduced the amount likely to be recovered by HMRC.

Why is it being reinstated?

This announcement has caused many to wonder why then, after a 16 year hiatus, HMRC are being awarded this considerable advantage in insolvency matters. The impetus of this historic change is, according to the Chancellor, “to ensure that tax which has been collected on behalf of HMRC is actually paid to HMRC”. Indeed, the Treasury has estimated that £185 million in taxes already paid each year, will reach the government as a direct result of this reversion to HMRC’s previous position.

The true motivation of this restoration is clear once the proposal is read in the wider context of the 2018 Budget which seeks to address tax avoidance, keep taxes low and crucially, provide additional funds to government departments to prepare for the UK’s departure from the EU. By providing HMRC with a preferential status in business insolvencies, it assures that it will receive a cash injection, in a sum much greater than under the previous regime whereby their entitlement would have been much reduced by higher ranking creditors.

Comment

This change will not be welcomed by floating charge holders who, finding themselves pushed further down the recoveries list, will see the value of their securities further eroded.

Naturally, any disturbance to the status quo will always be met with concern, but it is important to maintain perspective. This change will only be a partial reinstatement, as it will only apply to taxes held by companies on behalf of employees and customers (such as VAT, income tax and NICs). Implementation will also be subject to a consultation, providing the market with ample time to digest this currently unpalatable change.

Just as the balance tipped in favour of the trade creditors following the elimination of preferential status in 2002, the pendulum swings back, reinstating HMRC’s privileged position, what now remains to be seen is whether the market concerns are justified.

This article was co-authored by Alexandra Miller, Trainee Solicitor, London.