August 5, 2019

Insolvency snakes and ladders: HMRC climbs up as other creditors slide down

The new rules were initially announced in the October 2018 Budget. The Government has since held a consultation and, having received responses from professional advisers, including insolvency practitioners and lenders, published its findings on 11 July 2019.

From 6 April 2020, HMRC will take a step up the ‘insolvency ladder’, becoming a secondary preferential creditor for certain tax debts paid by employees and customers on the insolvency of a business.

The ‘insolvency ladder’

Under the existing legislation, any money realised from the assets of an insolvent company is used to meet the claims of creditors in the following prescribed order:

1. Holders of fixed charges and creditors with a proprietary interest in assets. This is usually mortgagors and the interests of trustees whose assets are held on trust by the insolvent company.

2. Expenses of the insolvent estate. The insolvency practitioner pays the expenses of the state - and his own fees - before dealing with any other claims.

3. Preferential creditors. For example, retail banking deposits up to the amount insured by the Financial Services Compensation Scheme - currently set at £85,000 per eligible person, per bank or £170,000 for joint accounts.

4. Holders of floating charges. These are typically banks or lending institutions; they receive any payments in the order of registration of each floating charge.

5. Unsecured creditors. They are paid on an equal basis meaning everybody gets the same amount of whatever is left in the ‘pot’ by this stage. HMRC currently sits here, together with suppliers and customers.

6. Shareholders. It is unlikely that by this stage, if not before, there would be sufficient funds for any further distributions.

The current ‘ladder’ means that, when a company becomes insolvent, the taxes that it temporarily holds on behalf of employees and customers are diverted and used to pay other creditors (ranking above HMRC), rather than reaching the Government to be allocated to public services, as intended.

Game changer

Businesses enrolled in PAYE typically retain a portion of employees’ income that relates to tax or student loan repayments and pay this directly to HMRC following monthly payroll. Occasionally, businesses will allow this ‘employee tax fund’ to accumulate and pay it on a quarterly basis.
The proposed changes will ring-fence any money in this fund, or otherwise owed to HMRC (e.g. VAT) and promote HMRC to a secondary preferential creditor in both corporate and personal insolvency. However, in practice, this will only apply to VAT, PAYE and employee National Insurance contributions, meaning it will mainly affect businesses insolvencies rather than individual bankruptcies.

It follows that, if HMRC are now higher up the ladder, holders of floating charges, unsecured creditors and shareholders are much less likely to be able to recover any money from the insolvent company or individual.

The Government appears keen to highlight the purported positive impact the changes will have on the public purse, with projections showing up to an £185m increase in funds towards public services by 2023. There is little regard, however, for the use of insolvency procedures to recover unpaid debts for unsecured invoice creditors.

The Government has, for the time being, ruled out similar changes for Corporation Tax or other tax liabilities of the business, meaning HMRC will remain as an unsecured creditor where these have not been paid.

Responses to the Government’s consultation highlight the following concerns:

• HMRC will have too much control over the insolvency process, having been given an enhanced position.

• The changes will undermine the benefit to the petitioning creditor for instigating the process.

• This will serve to delay the process and create additional administrative burdens for insolvency practitioners.

• That floating charge holders have the most to lose as a result of these measures.

• The proposal will impact upon existing rescue mechanisms such as administration and company voluntary arrangements (CVAs).

While the Government has downplayed the above questions, it has confirmed that this measure will not apply retrospectively and will only apply to insolvency proceedings post-6 April 2020, but will include any pre-existing floating charges remaining due as at the date of insolvency after that date.

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