From 1 December 2020, HMRC will regain its status as a preferential creditor in insolvency cases. Though there are still a number of unanswered questions, this change will undoubtedly have a significant impact on creditors’ involvement in insolvency processes.

HMRC was last classed as a preferential creditor in an insolvent event back in 2002. This was known as ‘Crown Preference’. In practice, it meant that following payment to existing preferential creditors, funds would then be distributed to the Crown as a ‘secondary’ preferential creditor. This would take place before any residual funds were distributed to a floating charge holder and then, finally, to unsecured creditors.

HMRC regains its preferential creditor status

The Enterprise Act 2002 effectively abolished Crown Preferences to put HMRC on an even keel with all other unsecured creditors. The only remaining preferential creditors were then arrears of wages, accrued holiday pay and pension arrears (up to certain limits). 

Most professionals would agree that this model has worked pretty well over the past 18 years. Unsecured creditors have been asked to be more active in insolvency procedures and, where they are likely to receive a return, we have seen some evidence of this.

In 2018, the Chancellor announced that Crown Preference would be restored for tax debts including PAYE, NICs and VAT. Notably, Corporation Tax will remain an unsecured debt. Royal Assent was received on 22 July 2020 and HMRC’s preferential status will take effect from 1 December 2020.

What difference will HMRC’s preferential creditor status make?

Many insolvency professionals were surprised at this change. It has been estimated that the change will result in an additional £250m of revenue being returned to HMRC, but at what cost to the economy? It appears very narrow thinking. In recent years, creditors have been encouraged to engage more with the insolvency process. However, as unsecured creditors will now only receive a distribution once HMRC have been paid in full, there are fears that unsecured creditors will not engage with many processes at all.

The knock-on effect of the new Crown Preference will not only impact the return of funds to unsecured creditors, but also lead to an increase in floating charge finance (which will rank below HMRC) and the tightening of lending criteria. Directors may also need to give personal guarantees to secure this type of finance.

It may also be the case that we see existing floating charge lenders call in their debts and/or force companies into an insolvency process prior to 1 December 2020 to mitigate their exposure.

There are a number of unknowns at this stage, but our Business Recovery and Insolvency team will be watching developments closely so we can best advise our clients.

By Jon Mitchell, Partner

 

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