On 26 February 2019, the government launched a consultation on proposals to make HMRC a “secondary preferential creditor”. Business owners, directors, lenders and insolvency practitioners have until 27 May 2019 to feedback on these proposals.
What creditors of companies or individuals in formal insolvency procedures receive from the insolvent estate will vary depending on the status of each creditor, and is determined by a statutory set of priorities. Currently, all tax debts owed to HMRC by an individual at the time they are declared bankrupt or a company at the time it is placed into administration, or wound up, rank as a “non-preferential unsecured debt”. This means that HMRC, together with all other unsecured creditors (such as trade suppliers), will receive a payout from an insolvent estate only after the following categories of creditor have been paid out in full: (1) lenders with a fixed charge security, (2) insolvency practitioners’ fees and expenses, (3) preferential unsecured creditors (including unpaid wages due to employees up to a certain limit), and (4) prescribed part* creditors. Only shareholders or the bankrupt rank lower than unsecured creditors in the priority of distribution of any funds from an insolvent estate.
Prior to 2003, HMRC was a preferential creditor for certain taxes, paid in priority to unsecured creditors, but its status was changed to that of a non-preferential creditor for all forms of tax by the Enterprise Act 2002. This was one of a number of measures taken to try to stimulate business recovery.
The government now says that the losses to the Exchequer have increased and to redress the balance they propose to change HMRC’s status as a creditor in respect of certain taxes. It is estimated that by 2023/24 this measures would add around £175m per year to the public purse.
So what precisely is proposed? Not all tax debts will have preferential status. The proposal only concerns tax debts for PAYE, employee national insurance contributions (NIC), construction industry scheme (CIS) payments and VAT due at the commencement of the insolvency. The logic is that these are taxes that a business collects from its employees/contractors (in the case of PAYE, NIC and CIS) or customers (in the case of VAT) on behalf of HMRC – an approach that is similar to the concept of protecting customer deposits paid to a business that becomes insolvent before delivering the goods or services paid for. There will be no time limit on old debts.
The proposal is that from 6 April 2020 these tax debts owed by a company or individual (as a sole trader or partner in a partnership) at the time of its formal insolvency will be paid after fixed charge lenders, insolvency practitioners’ fees and expenses and preferential unsecured creditors such as employees, but HMRC would be paid in priority to prescribed part creditors, lenders with a floating charge, and non-preferential unsecured creditors (such as trade creditors).
Other types of tax such as employer NIC, corporation tax and inheritance tax will continue to rank as non-preferential unsecured debts in all insolvent estates.
Concerns have been raised that the measures will add to cash flow pressures and hinder business recovery. However, the measure will not prevent businesses from using VAT and PAYE revenue to smooth short term cash-flow and will only take effect post-insolvency to give HMRC a greater priority relative to other creditors.
Insolvency Practitioners may be concerned that this will add a degree of complexity and additional administrative burden to dealing with an insolvent estate, and will emphasize the need for HMRC to provide proofs of debt that accurately break down the different categories of tax debt if the measure is to properly implemented.
Lenders with floating charges will be affected. The government points out that the amount by which lenders will lose out (estimated to a maximum of £185m per year) is minimal compared to the amount of bank lending to small and medium enterprises alone (£57billion in the 12 months to July 2018). There may be concern that this will still cause an increase in the cost of lending to businesses.
Unsecured creditors, such as suppliers may lose out. The government points out that it is unusual for this class of creditors to recover any of their debt from an insolvent entity. This proposal will not improve their situation, but the government says it does not make it any worse.
The full consultation is available at www.gov.uk/government/consultations/protecting-your-taxes-in-insolvency.
Responses are to be sent to [javascript protected email address] by 11.45pm on 27 May 2019.
* the prescribed part is a ring-fenced fund for unsecured creditors, calculated as 50% of the first £10,000 of available funds, and thereafter 20% up to a maximum of £600,000 – although there is a proposal to increase this to £800,000. As an unsecured creditor, HMRC does currently benefit from the prescribed part.
For more information contact our specialist Insolvency team or visit our Insolvency and Corporate Recovery page.
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