Beware HMRC has Regained Preferential Creditor Status

A recent change in the law saw the reintroduction of the ‘crown preference’ for insolvencies commencing on or after 1 December 2020.

Prior to 1 September 2003, HMRC was a preferred creditor in insolvency cases for certain taxes. This meant that they ranked above any ‘Floating Charge’ holders in corporate insolvencies.  The Enterprise Act 2002 abolished this right to enable ordinary creditors to have more of a chance to get a return in an insolvency situation.

The reintroduction of ‘crown preference’ gives HMRC secondary preferential creditor status for taxes collected from employees and customers and held by the business on HMRC’s behalf. This includes unpaid VAT, PAYE and Employee’s NI, Student loan repayments and Construction Industry Scheme deductions.  Note that HMRC will remain as an unsecured creditor for taxes it collects directly from a business such as Corporation tax and Employer’s NI.

The secondary preferential status means that HMRC will fall behind the ordinary preferential creditors which include:

• Contributions to occupational Pension Schemes
• Wages and holiday pay due to employees
• Levies on coal and steel production, debts owed to Financial Services Compensation scheme (FSCS)
• Deposits covered by FSCS
• Any individual debtors under the Reserve Forces (safeguard of Employment) Act

Impact of this Change

Whilst you may not think that this is a significant change, except for secured creditors with floating charges, there are several potential consequences to be aware of for businesses:

• Due to the increased lending risks it is expected that banks will look for better credit ratings and loan pricing. In particular smaller businesses may find funding harder to obtain as banks will place less reliance on floating charges.
• Businesses without assets to offer as security may struggle to get bank loans. If a bank can obtain security on a particular asset, then it will push them above preferential status in the event of an insolvency. Invoice financing may now feature early on in any discussions re finance requirements.
• In turn this may lead to earlier/increased discussions on personal guarantees required from directors in respect of business borrowing if there are no assets
• Creditors’ returns in an insolvency will be reduced dramatically
• Restructuring mechanisms such as Company Voluntary arrangements (CVA’s) may be more difficult to get approved as preferential creditors, including HMRC, may decide that they will get a higher immediate return from putting a company into liquidation.

The information in this blog provides only an overview of HMRC guidance and legislation in force at the date of publication and no action should be taken without consulting the detailed HMRC guidance and legislation or seeking professional advice.  Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this blog can be accepted by the firm.