The UK government has published a draft Finance Bill 2020, which includes a provision that, if enacted, will give HM Revenue & Customs (HMRC) secondary preferential creditor status for certain taxes which a company has collected but failed to pay to HMRC on the date it enters insolvency.
HMRC currently ranks as an unsecured creditor on a company’s insolvency. The new draft finance bill would change that: taxes which are covered by the provision would be accorded priority status and paid to HMRC out of the insolvent company’s estate ahead of the “prescribed part”, secured creditors with a floating charge and unsecured creditors. Secured creditors with a fixed charge, insolvency practitioners’ fees and expenses, and current preferential creditors would continue to rank ahead of HMRC.
HMRC would remain an unsecured creditor for any other taxes, such as corporation tax, which relate to the business itself.
HMRC’s priority status would be limited to VAT, Pay As You Earn (PAYE), employee National Insurance Contributions (NICs) and Construction Industry Scheme Deductions. These categories broadly represent taxes which have been collected by a company on behalf of other taxpayers, such as its employees and customers, which the company is obliged to pay over to HMRC.
The government’s stated aim of the change is to ensure that when a business enters insolvency, “more of the taxes paid in good faith by its employees and customers, and temporarily held by the business, will go to fund public services rather than being distributed to other creditors”.
If the proposals come into effect, they would apply to any administration or liquidation which commences after 1 December 2020.
Although the provision is unpopular with secured lenders, particularly in the ABL space, its effects could be mitigated with regular reporting and by implementing and managing appropriate reserves. This is particularly important for secured creditors who are lending against inventory. Inventory is a “floating charge” asset in the United Kingdom and therefore recoveries from the company’s inventory will be primed by HMRC’s new status as a secondary preferential creditor.
One of the changes in the draft finance bill from the earlier consultation papers is that penalties for failing to pay the relevant taxes would no longer form part of HMRC’s secondary preferential claim. This means that it should be relatively easy for a company to quantify the amount which would be payable to HMRC as a preferential payment.
It would make sense for an ABL lender to require that the frequency of reporting of the amount of the preferential claim is increased if the ABL lender has concerns about the borrower’s insolvency—this could step up to daily reporting if necessary—and an adjustment to the reserve as a result. Another option could be to require the company to maintain an amount equal to its unpaid VAT, PAYE, etc., in a separate account – either from the outset of the loan relationship or upon an agreed trigger event if the ABL lender was starting to have concerns about the company’s solvency.