Restoration of HMRC as a secondary preferential creditor

HM Revenue & Customs sign incised into the wall outside their headquarters in Whitehall, City of Westminster, London Print publication


In last year’s Budget, the government announced that it will 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.

On 26 February 2019 HMRC launched a consultation inviting comments on how HMRC proposes to implement the change. HMRC is seeking views from interested parties, particularly businesses, lenders, insolvency practitioners, advisers and representative bodies and others who will be affected by the change, to ensure that it is implemented in the most effective way.

The change will have effect for insolvencies commencing on or after 6 April 2020 and will cover specific tax debts, including VAT, PAYE (including student loan repayments), employee NICs and construction industry scheme (CIS) deductions (together with any interest or penalties arising from such debts). The government’s view is that these are taxes paid by employees and customers and held by the business on behalf of HMRC, and should be protected in an insolvency.

The changes will see HMRC become a secondary preferential creditor and move up the creditor hierarchy, ahead of holders of floating charges (mainly financial institutions) and other non-preferential unsecured creditors.

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 net orderly liquidation value (NOLV) 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.

This will impact significantly on the availability of ABL funding.  It will also have the effect of destroying the value of Time to Pay agreements for companies that use ABL facilities to fund working capital, since the amount of any Time to Pay deferral will be deducted pound for pound from available headroom under those facilities (to the extent that that headroom derives from inventory or plant and machinery).

This will have the effect of making full ABL facilities less attractive or available just as the UK is trying to trade out of any downturn following Brexit (and requiring access to increased working capital availability to do so). It remains to be seen whether the recent changes to the rules on assignability of debts  due to small and medium sized companies arising under long term contracts will make up the shortfall.

The consultation closes on 27 May 2019.