14 December 2020

Crown preference: Back to the Future? (not quite)

It’s been a while coming but Crown preference made its return on 1 December 2020, changing the order in which creditors will be paid in an insolvency situation. For almost 20 years, HMRC hasn’t received any special treatment when it comes to insolvency pay outs but is the change really that radical or have we just picked up where we left off?

Potted history

Prior to the coming into force of the Enterprise Act 2002 (i.e. before 20 June 2003), HMRC was classified as a preferential creditor in an insolvency situation. Put simply, creditors ranked as follows:

Ranking Order of payment
1.
    Fixed charge holders (out of net fixed charge realisations)
2.
    Insolvency costs and expenses
3.
    Preferential creditors (including HMRC in respect of unpaid taxes)
4.
    Floating charge holders
5.
    Unsecured creditors
6.
    Shareholders

The Enterprise Act then changed all of that and HMRC instead became an unsecured creditor, ranking much lower down the list:

Ranking Order of payment
1.
    Fixed charge holders (out of net fixed charge realisations)
2.
    Insolvency costs and expenses
3.
    Preferential creditors (excluding HMRC)
4.
    Prescribed part for unsecured creditors (up to £600,000 per company)
5.
    Floating charge holders
6.
    Unsecured creditors (including HMRC)
7.
    Shareholders

Climb back into your DeLorean and fast forward just over 15 years to the Autumn Budget 2018 when it was announced that creditor rankings would change again. Initially due to take effect earlier this year, on 6 April, the reordering was postponed because of COVID-19 and instead came into force on 1 December 2020:

Ranking Order of payment
1.
    Fixed charge holders (out of net fixed charge realisations)
2.
    Insolvency costs and expenses
3.
    Ordinary preferential creditors
4.
    Secondary preferential creditors, i.e. HMRC in respect of VAT and any "relevant deductions"
5.
    Prescribed part for unsecured creditors (up to £600,000 per company)
6.
    Floating charge holders
7.
    Unsecured creditors (including HMRC for other tax debts such as corporation tax and employer NICs)
8.
    Shareholders

The end result

While HMRC has moved back up the payments list, it will still rank behind ordinary preferential creditors (unlike back in the day when there was no differentiation) and will only rank ahead in respect of taxes which a business collects and pays on behalf of others, such as VAT, employee National Insurance contributions, PAYE income tax, Construction Industry Scheme deductions and student loan deductions; in respect of taxes owed by a business, HMRC will continue to rank as an unsecured creditor.

The effect

The main effects of the new rankings will be felt by those creditors lower down the priority list, such as floating charge holders and unsecured creditors, who may well find that there is little left in the pot by the time they receive any pay out.

Delaying the change in an attempt to weather out the pandemic may also not have had the intended result, given that many businesses which are suffering financially will now owe more to HMRC than they did back in April, for example if they have utilised the Government’s VAT deferral scheme.

The future?

We suspect that if we fly through the space-time continuum another 20 years, the rankings may have changed again, perhaps to remove the HMRC preference and then again to reinstate it. At least we can rest assured that any such changes are unlikely to destroy the entire universe.

Elizabeth Small is a Partner in the Tax team.

Disclaimer

This note reflects our opinion and views as of 11 December 2020 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

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