The return of the Crown as a preferential creditor – what is the impact on businesses?

During the Budget speech in October 2018 it was announced that the Government planned to reinstate the Crown as a preferential creditor for certain taxes in insolvency procedures.

The policy change is due to take place on 6 April 2020.

The proposed change

Prior to 2003, HMRC had preferential status for a number of taxes with its ability to claim preferentially limited to 12 months prior to the date of insolvency for PAYE and 6 months for VAT.

In 2003, following the introduction of the Enterprise Act 2002, the preferential status of the Crown was removed with one aim being to ensure that trade creditors in an insolvency process benefitted from an increase in dividends.

The new policy will see the Crown gaining preferential status regardless of when the tax liability was incurred.  Preferential status will be given in respect of VAT, PAYE, employee NIC and construction industry scheme (CIS) payments.

Impact on unsecured creditors

The reintroduction of preferential status for HMRC and the lack of a time cap on preferential claims will significantly and detrimentally impact on the level of dividends returned to ordinary unsecured creditors.

It is also likely to hamper the use of Company Voluntary Arrangements as a mechanism for rescuing or restructuring companies with any proposal needing to address that HMRC will be paid in preference to unsecured creditors.   

Impact on secured creditors – floating charge holders & future funding

Preferential creditors have priority over assets secured by a floating charge, such that they will get paid in an insolvency process from the proceeds of floating charge assets ahead of a lender holding a floating charge. These floating charge assets can include stock, plant and machinery and, in certain instances, book debts.

Many lenders hold a floating charge as part of their security package, and the reintroduction of preferential status will reduce the value of this security.

Beavis Morgan group business, BM Advisory, comments:

It is difficult to see this as anything other than a ‘money grab’ by the Government with little thought applied to the potential impact.

The Insolvency Rules 2016 rightly sought greater engagement from ordinary unsecured creditors in insolvency procedures. The reduction in dividends to unsecured creditors as a result of HMRC preferential claims will lead to creditors being further disenfranchised from the insolvency process.

The potential impact on funding of small and medium sized businesses is also of concern. Lenders may alter how their security is structured to ensure full coverage of the funds advanced to companies. This change in funding structures may result in increased costs and funders may seek additional security and personal guarantees to cover the reduced realisations from floating charge assets in a distressed situation.

Businesses may also find that funding is harder to obtain or that the level of funds advanced may be restricted as a result of the reduced security available to lenders.

Representations by the business community are continuing to be made to the Government, however it is understood that there is unlikely to be any amendment to the re instatement of HMRC as a preferential creditor.   

BM Advisory has extensive experience in providing restructuring and insolvency solutions across many sectors. If you consider a client could benefit from a free of charge/no obligation meeting with BM Advisory to explore the options available to them or seek further advice on the above, please contact Andy Pear, Mike Solomons or your or your usual Beavis Morgan Partner