Plans to restore HMRC as a secondary preferential creditor take a step closer to reality – where now for the Rescue Culture?

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As we reported earlier this year, the government announced in the 2018 Budget that it planned to introduce legislation to make HM Revenue and Customs (HMRC) a secondary preferential creditor for certain tax debts paid by employees and customers on the insolvency of a business. HMRC is currently an unsecured creditor for all of its debts.

On 11 July 2019, draft legislative provisions for inclusion in the Finance Bill 2020 aimed at putting the proposals into effect were published. The draft legislation will give priority to HMRC in relation to VAT, PAYE (including student loan repayments), Employee National Insurance Contributions (NICs) and Construction Industry Scheme Deductions in insolvency proceedings. HMRC would remain an unsecured creditor for direct taxes such as Corporation Tax and Employer NICs.

The draft legislation follows HMRC’s earlier consultation on the subject which also proposed that penalties relating to the relevant taxes would also attract secondary preferential status, however that element of the proposal has been dropped.

The proposal would place HMRC, in respect of its claims for the relevant taxes or amounts, in front of ordinary unsecured creditors (which is where such claims would otherwise rest). In corporate insolvencies, this would also place HMRC, for these amounts, in front of floating charge holders (mainly financial institutions) and the prescribed part (a ring-fenced amount set aside for unsecured creditors in front of floating charge creditors, which was put into place when “Crown preference”, as such preferential treatment was then known, was abolished in 2002). According to Government, “this change will enable more of those taxes paid in good faith to go to fund public services as intended”.

As reported previously, HMRC’s proposals are that all arrears of PAYE (including student loan repayments) and VAT outstanding at the point of insolvency are to be preferential. This will have a significant impact on the calculation of the value applied by asset based lenders (ABLs) to floating charge assets (inventory and plant and machinery) since on a break-up of the business, all outstanding PAYE and VAT will be paid out of the proceeds of sale of those assets in priority to the ABL under the floating charge.  It will be difficult, if not impossible, for a lender to ascertain with any degree of certainty what those sums might amount to when the time comes to rely on its floating charge security.

The inability to value, with any certainty, likely realisations from the stock in trade of a failing business will make it much harder for ABLs to lend any funds against that security, since it will increase the risk of loss substantially. The knock on effect of this, in our opinion, will be to reduce, significantly, the availability of ABL funding, especially in the SME market.  This view is in stark contrast to that of Government which states that it “does not expect the changes to have a material impact on lending”.

The proposals have elicited controversy within the insolvency profession, not least because they ignore the fact that when Crown preference was originally abolished by the Enterprise Act 2002 it was stated to be as a quid pro quo to the introduction of the prescribed part which made funds available from the enforcement of every floating charge and which are paid to unsecured creditors rather than the financial institutions holding the floating charges and in an attempt to foster a “rescue culture”. It would seem that there has been little regard had for that rescue culture in these proposals.

The changes will apply to insolvencies commencing on or after 6 April 2020. The draft legislation is open for technical consultation until 5 September 2019.