HMRC regains its preferential status

The Finance Act 2020 provides that, from today, HMRC will become a secondary preferential creditor in both corporate and personal insolvencies in respect of VAT and certain tax debts which comprise “relevant deductions”.

A “relevant deduction” includes PAYE, employee NI deductions, amounts withheld under the construction industry scheme and student loan repayments obtained from payroll deductions.

Other taxes, such as Corporation Tax and employer NI liabilities, which are assessed directly on the company, will remain non-preferential creditors. Equally taxes such as Income Tax and Capital Gains Tax, which are assessed on the individual will remain non-preferential in status.

Debts which have previously received preferential status under the insolvency legislation – most commonly employee wages and holiday pay – will be paid in full ahead of HMRC’s secondary status.

Some key aspects are:

• HMRC’s new status applies to all insolvencies commencing on or after 1 December 2020.

• There is no cap on the age of “certain tax debts” and preferential status will apply to the whole of the debt existing at the commencement of the insolvency, not simply those liabilities that have arisen since 1 December 2020. This is significantly different from the position prior to 2003 when HMRC lost its preferential status.

• Any interest and penalties in respect of VAT and the certain tax debts will not receive preferential status.

The effect of preferential status is that the claims will rank ahead of those of creditors secured by a floating charge and non-preferential creditors. The claims of fixed charge holders remain unaffected.

Lenders who rely on floating charge security or who calculate their lending exposure based on floating charge recoveries are likely to see their security eroded due to these changes.

This, in turn, is likely to have consequences on the level of continued support from lenders, the availability of new or additional finance to a business, as well as the possible financial impact on anyone who has provided a personal guarantee to a lender which is no longer able to recover its indebtedness under a floating charge.

At the time of the original consultation it was estimated that these changes would produce a maximum annual yield of £185m in additional tax revenues. It is difficult to understand why these changes were not withdrawn, or at least delayed, due to the current economic situation and the cost going forward in terms of lost support to business could well be far greater.