As of 1 December 2020, HMRC will be considered a preferential creditor in insolvency proceedings, a status it formally held until 2003. This could have serious implications for both creditors and struggling businesses, as HMRC will have greater influence over insolvency proceedings.

Status of creditors

When it comes to insolvency proceedings, not all creditors are made equal. Instead, they are categorised as a preferential creditor, a secondary preferential creditor, and so on. Payments are made according to this order of priority. In practical terms, this means that an employee waiting to receive outstanding wages is paid ahead of a supplier.

HMRC as a preferential creditor

Thanks to the introduction of the Finance Bill 2020, HMRC will now enjoy secondary preferential status in certain situations. This represents an upgrade from its former status as a non-preferential creditor.

Specifically, HMRC will sit higher in the creditor hierarchy, should a business owe Pay As You Earn Income Tax (PAYE), Value Added Tax (VAT), employee National Insurance Contributions (NICs), student loan repayments or Construction Industry Scheme deductions. This includes PAYE/NIC deductions that were withheld by a business under the Coronavirus Job Retention Scheme.

For all other debts – such as Corporation Tax – HMRC will remain a non-preferential creditor.

Why has the law been changed?

The government announced these plans in the 2018 budget, but the laws have only just come into effect. In a press release on the website, HMRC explains that:

“Where an employer becomes insolvent, it may be holding funds due to HMRC at the time of its insolvency. Without special protection these funds would be used to pay other creditors, rather than HMRC as intended.”

HMRC is therefore targeting funds that have been paid by other parties – most notably employees and customers – and held by the business. Ordinarily, these funds would then be paid to HMRC in one lump sum, with the business merely acting as an intermediary. But in an insolvency situation, these taxes are instead used to pay various creditors, rather than handed over to the government to fund public services. That is why tax liabilities incurred by the business, such as Corporation Tax, remain a non-preferential debt.

A return to Crown preference rules

The so-called ‘Crown preference rules’ are not entirely new. HMRC was previously considered a preferential creditor, until this status was abolished by the Enterprise Act 2002. Previously, however, HMRC only enjoyed preference over outstanding tax liabilities in the 12 months prior to insolvency proceedings. Now, there is no time cap, meaning preferential status can be given to debts dating back over many years.

What impact will the Finance Bill 2020 have?

The new rules apply to all businesses that enter into insolvency proceedings on or after 1 December 2020. There have been reports that this forced some businesses into early insolvency proceedings, as creditors were keen to get the ball rolling before 1 December, for fear of losing out to HMRC.

Going forward, there are also concerns that HMRC will now have greater influence over insolvency proceedings. This is likely to impact Company Voluntary Arrangements (CVAs), where preferential debts can only be compromised with the creditor’s consent. HMRC may therefore veto any proposals, as their interests may not align with other creditors.

Furthermore, those classified as floating charge and unsecured creditors could now see diminished returns following insolvency proceedings, as HMRC will get the first bite of the cherry. As a result, lenders may be less willing to lend to businesses who are struggling financially – something which won’t be welcome news in this difficult economic climate.

Insolvency experts

If your business is failing to meet its debts but you want to continue trading, you need to get expert legal advice – and fast. With the correct action, you can achieve an effective resolution. There are various options available. We will explain these in greater detail, acting as your legal representative throughout insolvency proceedings.

For a confidential discussion with our solicitors, please contact us today at Altion Law.

Call us on 01908 414990 or complete our online enquiry form and we will get back to you.