Budget prefers HMRC in insolvency
Much of the legal analysis on the impact of the recent Budget has focused on the announcement of changes to Entrepreneur’s Relief that will have a significant impact on many shareholders looking to benefit from this tax break (see our tax expert Elizabeth Middleton’s news post on that here).
Another seemingly subtle change to the pecking order of creditors in insolvency, however, could have wide-ranging consequences for lenders and unsecured creditors. HMRC will (once the relevant legislation has been enacted) be returned to preferential creditor status (see here), meaning that it will rank ahead of floating charge holders and unsecured creditors. Debts owed to HMRC by the insolvent company in respect of VAT, PAYE income tax, employees’ national insurance contributions and Construction Industry Scheme deductions will receive preferential treatment, but this will not apply to corporation tax or employer’s national insurance contributions owed by the insolvent company. The Government estimates that HMRC will be able to recover on average 14% of its preferential debts under the new regime, an increase of 10% from its current recovery rate.
HMRC historically benefitted from preferential treatment in the event of a company’s insolvency, but this was abolished by the Enterprise Act in 2002. This legislation heralded the introduction of the current three-stage statutory purpose of administration, with the main focus being on company rescue, as well as a move away from administrative receivership (where control rested with a single secured creditor) towards administration (a collective insolvency procedure). The recent about-turn and reinstatement of HMRC as a preferential creditor seems at odds with the Government’s promotion of a rescue culture and R3 fears it could be a “retrograde and damaging step to UK plc if not thought through carefully” (see report here).
The Government estimates that preferential creditor status would increase recovery of taxes by £185m per year, but there are concerns that it may encourage a hardening in HMRC’s approach towards debt collection, and could signal an increase in winding-up petitions presented by the Revenue. The pool of assets available to floating charge holders would also be reduced, as HMRC would take their cut first, whilst leaving fixed charge holders protected at the top of the priority pile. This may result in lenders pressing for more control over secured assets to ensure that their charges are classed as fixed rather than floating. Last but not least, with the pool also being shrunk for unsecured creditors, they are likely to feel even more disengaged with the insolvency process and will on average (the Government predicts) recover less than 4% of debts owed to them by the insolvent company.