22 October 2019

Alien Vs Creditor: Requiem

If you wait long enough everything comes back into style.

The Finance Bill 2019-2020 due to take effect from 6 April 2020 (and so applying to any insolvencies starting on or after that date) will bring back (partially) the concept of Crown Preference in insolvency cases. Whilst not applying across the board, HMRC's argument is that taxes such as VAT, employee NICs, PAYE, payments subject to the Construction Industry Scheme and other relevant withholding payments are taxes that companies collect on behalf of HMRC, and so in effect are holding these sums for the Crown. The new legislation does not apply to other taxes such as Corporation Tax or Stamp Duty Land Tax.

Crown Preference is not an alien concept. Before being scrapped by the Enterprise Act 2002 (from 15 September 2003), HMRC was treated as a preferred creditor when a company went insolvent. Sitting behind fixed creditors but ahead of floating charge holders and other unsecured creditors, the practice became viewed as a detriment to helping struggling companies.  HMRC, with deeper pockets and more ability to shoulder losses was more willing to start the winding up petition against a company in difficulty, knowing it would likely recover some of what it was owed.  Other smaller creditors, for whom a bad debt unpaid or obtaining a negligible amount for each £1 of debt, could have major negative knock on impacts were less likely to rush into issuing a winding-up petition.

The Enterprise Act 2002 marked a significant shake up to insolvency law, seeing HMRC fall from a preferential creditor for all taxes to just another unsecured one, a move designed to make lenders feel more comfortable providing unsecured loans or floating charges to businesses in distress, providing an environment whereby struggling businesses were more likely to avoid insolvency. With the Revenue often an insolvent company's largest unsecured creditor it is perhaps unsurprising that the prospect of reintroducing preferential treatment has reared its head.

The new proposals aren't quite full preferential creditor status. HMRC wants preference on any tax that the insolvent company effectively collected on its behalf. The legislation states that HMRC takes preference in respect of "value added tax or a relevant deduction" with a deduction being relevant if "the debtor is required… to make the deduction from a payment made to another person and to pay an amount to the Commissioners on account of the deduction, the payment to the Commissioners is credited against any liabilities of the other person and the deduction is of a kind specified in regulations made by the Commissioners by statutory instrument." Any withholding taxes or requirement to deduct an amount and pay it to HMRC is argued to be identifiably HMRC's money and so the argument goes HMRC should rank before other creditors in having access to funds to fulfil these debts. HMRC's policy paper on the matter plays up the loss of tax revenue to "fund public services" with HMRC as a current unsecured creditor and claims without citation that the change will primarily affect financial institutions.

In fact HMRC will still rank below fixed charge lenders, so most major bank lenders are unlikely to be affected.  Lenders offering floating charges to smaller businesses which are not backed by substantial property interests (or those businesses that need further funding having already charged their property interests to the high street banks) will be at greater risk.  This is likely to lead to reduced funding being offered alongside higher borrowing costs if lenders seek to insure their loan against HMRC's preference.  

With HMRC projecting that it will gain £195m in the tax year 2022/2023 the obvious losers are struggling individuals and those businesses needing finance which do not have assets that they can take out fixed charged loans against (particularly stock heavy businesses, companies in manufacturing or those which have large numbers of employees and so are likely to have significant withholding requirements) which may already be feeling the pinch in a tight economic climate.

HMRC as a preferential creditor will see them once again playing a larger role in any insolvency procedure, the not so alien concept returns for round 2.

Whilst the Government spin is that this is allowing HMRC to get funds that it was due at the expense of financial institutions, the real losers may well be ordinary trade creditors (who have moved further down the priority of debtors) and struggling businesses who are likely to see their costs of borrowing rise and their access to funding drop.

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