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Is the UK’s HMRC short sighted in restoring Crown Preference?

Is the UK’s HMRC short sighted in restoring Crown preference at a time when many SME’s and their lenders are already struggling? 

From 1 December 2020, arrears of crown debts (unpaid VAT, PAYE, employee national insurance contributions and CIS deductions) will obtain secondary preferential status. This means they will rank ahead of some debts secured by lenders, reducing cashflow for businesses and increasing personal exposure for guarantors.

 What’s proposed?

The Finance Bill 2019-21 recently received Royal Assent and HMRC will again become a secondary preferential creditor. Many involved in restructuring and insolvency have long campaigned against this, fearing adverse consequences for businesses, their lenders and their owners.

Protecting your taxes in Insolvency? 

 The government first announced its intention to revise the status of Crown taxes in insolvency proceedings in the 2018 Budget, after previously abolishing them in 2003. According to HMRC “When an organisation goes insolvent, the taxes that it temporarily holds on behalf of its employees and customers may be used to pay other creditors rather than be spent on public services”. 

The government view is that this change is a fair approach that balances the interests of the creditors and the Exchequer, which relies on those taxes to fund public services. HMRC estimates the change will raise around £185m a year for the government.

The creditors most impacted by the change are those HMRC will now supersede, principally ‘floating charge’ secured lenders (who lend against moving asset classes, such as stock) and unsecured creditors. This includes pension schemes, some employee claims, and the company’s suppliers or customers – which may include small businesses and consumers. The extra money HMRC gets will come from what would otherwise have been repaid to these creditors. 
Floating charge lending, such as asset-based lending or invoice discounting is a common form of business finance for many SME’s. Following the changes, floating charge lending will essentially become riskier, as in the event of insolvency, if there are outstanding crown debts, these will be paid first, leaving little prospect of any return to other creditors through the insolvency process. Consequently, Lenders may be less willing to continue lending without the provision of additional security, such as the insistence of personal (increased) guarantees from Directors. 

Introduction at a critical time for business…

Its implementation couldn’t come at a more critical time for business and their lenders. Businesses grappling with the impact of the pandemic on their finances and the uncertainties surrounding future revenues, will have to adapt to the ‘new’ normal, which itself will come at a cost and stretch many businesses to breaking point. 

Rethink required?

At a time when many businesses will need all the support they can get, many lenders will be reassessing funding availability against Crown debts inflated by the governments vat deferral scheme and contemplating getting in first ahead of the changes in status. Many will not survive.

The extra money HMRC gets as part of the changes, estimated at £185m by 2022/23 – is likely to be far outweighed by the damage that could be caused to the UK economy. An urgent rethink is required. 
Tyrone Courtman
Former Founding EACTP President 
Partner, RSM Restructuring Advisory LLP 
November 2020  

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