Partner Article

HMRC’s preferential status in insolvency

Jeremy Oddie, corporate recovery and insolvency partner at North West accountancy firm Mitchell Charlesworth, comments on the Government’s plans to make HMRC a secondary preferential creditor in insolvency.

On 11 July 2019, the UK government published draft legislation for the Finance Bill 2019 which contains important changes to insolvency law.

From 6 April 2020, HMRC will have secondary preferential status for taxes collected by businesses on behalf of taxpayers (including VAT, PAYE income tax, employee National Insurance Contributions and Construction Industry Scheme deductions). This is in part, a return to the preferential status held by HMRC in 2003 but surrendered in the reforms brought in that year.

The proposals have caused real concern amongst lending and insolvency professionals as they do not address questions about the impact of this change on existing facilities and future lending. Leading businesses groups and insolvency experts have written to the Chancellor warning that the plans ‘will have serious consequences on the UK economy’.

The concern arises from the effect that the HMRC proposal causes in relation to those stake holders and financial institutions that have entered the funding market since the banking crisis in 2008. These lenders more often rely on floating charge recoveries or calculate lending exposure based on floating charge recoveries and are at odds with the changes.

A floating charge is a form of security granted to a lender over general assets of a company which may change from time to time in the normal course of business (e.g. stock). The company can continue to use the assets in its business until an event of default occurs and the charge crystallises. If this happens, the secured lender can realise the assets to recover his debt, usually by appointing an administrative receiver, and obtain the net proceeds of sale subject to the prior claims of the preferential creditors.

These lenders, primarily asset based lenders (ABLs), have taken comfort from their ability, when lending, to recover exposure from the floating charge realisations in the event of an insolvent failure. Borrowers have been able to utilise the value of a floating charge surplus to obtain and enjoy cash flow funding. Both lenders and borrowers now face the prospect of not having that surety. ABLs will now require borrowers to both track and report their HMRC liabilities more frequently and more precisely than in the past and lenders will now want certainty on the HMRC liability position as part of any new lending consideration.

In the event of an insolvency occurring, a lender relying on the floating charge will be less likely to see recovery of the funds that they have lent. The net effect is that lenders will either demand greater degrees of personal security on corporate lending or will simply restrict the funds they lend. Either way this is likely to impact on the volume of new lending to healthy businesses and reduce the willingness of lenders to consider assisting struggling businesses. It will also undoubtedly make for more expensive borrowing at a time of marginal growth in the private sector which is already facing much uncertainty.

Many of the accountancy and insolvency bodies have raised what they consider are grave concerns at what they see as an ill-conceived and rash action by HMRC. HMRC disagree with this view and are determined to press ahead with the changes claiming that they will further improve recoveries of unpaid tax from insolvent companies for the national benefit.

As is always the case, there are two sides to every story but this does appear to be a case of HMRC wanting to return to the days of full preferential creditor status and regain the privileged status previously enjoyed.

From the perspective of the borrowers, expect your lender to be more diligent, be able to provide timely and accurate information regarding your liabilities and do not be surprised if it costs you more to borrow.

The draft legislation will go out for consultation until early September with plans to pass the Finance Bill after Budget 2019 this autumn, following the current Brexit deadline of 31 October. We will provide further updates when any announcements are made by the Government.

This was posted in Bdaily's Members' News section by Anne Griffiths .