HMRC to regain its status as preferential creditor in insolvencies

The Finance Act of 2020 will see HMRC regain its status as preferential creditor for insolvencies on or after 1st December 2020.

What this will mean is that in an Administration or Liquidation, HMRC moves up the ranking as to who will get paid first ahead of floating charge and unsecured creditors.

Currently employees and the Financial Services Compensation Scheme (FSCS) are the only preferential creditors in an insolvency.

Accordingly, come 1st December , HMRC will join the FSCS as secondary preferential creditor in relation to outstanding tax deductions made by employees and customers and “held” by a Company namely PAYE, VAT , Employee NIC contributions, Student Loan and CIS deductions.

Crucially, there will be no cap on the age of the liability that now attracts the preferential status.

HMRC will remain an unsecured creditor for corporation tax and employer NI contributions as these are classed as “taxes owed by the business itself.”

This will clearly have an impact on HMRC’s stance moving forward in allowing liabilities to accrue. It is worth noting however, that the further extension to those measures currently in place to protect businesses from insolvency, such as the restriction of statutory demands and winding up petitions from aggressive creditor action until 31st December 2020, seems to be stemming the pressure on businesses adversely affected by Covid-19.

How will the changes impact lenders?

HMRC have stated that these changes will “ensure that when a business becomes insolvent , more of the taxes paid in good faith by its employees and customers will fund public services, rather than distributed to other creditors such as financial institutions”.

In an already challenging economic environment, these changes are expected to have an immediate impact on asset-based lenders.

In instances whereby a lender holds a fixed and floating charge, the changes to HMRC status will not impact on assets subject to a fixed charge but will now take precedence over any floating charges held by a secured creditor (lender).

These are often current assets such as stock, receivables (unless subject to an invoice finance agreement) and cash at bank. It is safe to say that when these changes become effective, the value of security available to lenders will be depleted.

Whilst many businesses have traditionally used tax funds as part of ongoing cash flow to provide much needed liquidity when cash pressure mounts , lenders typically have been able to support business growth , rescue and turnaround by relying on floating charges for security for example stock/inventory finance and loans secured against cashflow /work in progress.

However with funds available for floating charge security being significantly reduced and HMRC status in insolvency now considerably strengthened, it is almost inevitable that many lenders will be far more wary of allowing high HRMC debts and potentially reducing or even withdrawing their levels of financial support.

Further consideration should also be made in respect of personal guarantees requested by the lender to supplement its security. Where such guarantee is requested to support a facility, directors will need to be extremely mindful that any additional liabilities owed to HMRC will now reduce the return available to a lender , which may impact on the amount requested by them under their pledged personal guarantee.

With HMRC debt increasing for many companies amidst a renewed lockdown period, it remains a deeply testing time for UK businesses. Here at Advantedge we continue to work extremely closely with our clients to ensure our continued support and to provide guidance for them for the challenges that lay ahead.