The Chancellor of the Exchequer exercised exemplary foresight in delivering the Autumn Budget 2018 early (usually set for a Wednesday in November), neatly avoiding both the inevitable ghoulish Halloween-headlines and the impending (and possibly equally ghoulish) Brexit negotiations fixed for November.
With current affairs awash with reports of finance-stricken companies entering formal insolvency procedures, we consider an important change introduced in Mr Hammond’s Budget and, in particular, the risks and ramifications of HMRC’s rise in status to that of preferred creditor in corporate insolvencies.
HMRC is no stranger to the enviable position of the preferred creditor. Up until 15 September 2003, HMRC enjoyed preferential status (pursuant to Schedule 6 of the Insolvency Act 1986) in respect of PAYE, deductions made under the Construction Industry Scheme (CIS) and National Insurance Contributions (NICs), VAT and other smaller duties.
The key legal principle is that preferential creditors, by reason of their ranking, benefit ahead of floating charge security holders and unsecured creditors in any distribution made from realisations. As a preferred creditor, HMRC formerly had comfort in knowing that when it petitioned for the winding-up or bankruptcy of a tax debtor, it would participate equally with other preferential creditors in the distribution of assets realised, after the deduction of fixed charge security holders and insolvency costs.
On 15 September 2003, a number of insolvency-related provisions of the Enterprise Act 2002 came into law, amongst which was the removal of HMRC’s preferential status. The result was that tax authorities now ranked equally with the general body of unsecured creditors for a dividend, thereby receiving a payment out of assets, if there was anything left, after the deduction of fixed security holders, insolvency costs, preferential creditors and floating charge security holders.
The consequence for HMRC was no doubt significant; the consequence for unsecured creditors was potentially colossal and to be celebrated.
Last Monday 29 October 2018, the Chancellor declared that, effective April 2020, the Government will once again make HMRC a preferred creditor in business insolvencies “to ensure that tax which has been collected on behalf of HMRC is actually paid to HMRC”; the reasoning being that VAT, PAYE, NICs and CIS deducted from companies’ customers and employees are regarded as temporarily held on trust by the company. There is a presumption, therefore, that the Government considers the funds to be ring-fenced specifically for HMRC and not for distribution to the general body of creditors.
HM Treasury’s expectation is that “the measure seeks to tackle and prevent taxpayers from artificially and unfairly avoiding tax by misusing insolvency to retain their avoidance or evasion gains, or benefit from repeated non-payment of tax (known as ‘phoenixism’).” The impact to the Exchequer, as provided for in the Government’s Policy Costing document, anticipates an increased recovery in excess of £65million for the year 2020-21 rising to over £185million for the year 2023-24.
The inevitable and unenviable result for unsecured creditors is that there will be a smaller pot of money from which they will receive a dividend, if indeed there is any pot at all after higher ranking creditors are satisfied. The general response to the change from unsecured creditors and floating charge holders, who have had dealings with distressed companies, is likely to be less than favourable. There is though a glimmer of hope, for such creditors, in the form of proposed consultations, which may bring about some variation to the Chancellor’s present intentions.
It is understood that a consultation will be carried out before the changes are introduced. The trade association for UK insolvency and restructuring professionals, R3, has said that the major policy change for HMRC “could potentially be a retrograde and damaging step to UK public limited companies if the plans are not thought through carefully”. They fear that the reduced dividend payments to a whole body of creditors will reverse the rescue culture that has been encouraged since 2002 and destabilise the confidence of lenders, suppliers and small businesses in determining their next investment opportunity or business deal.
It remains to be seen whether the consultations will bring about any variations or, indeed, provide the much needed justification and evidence for such a seismic change. In the meantime, unsecured creditors will be left wondering if they will, at least, see any indirect benefit from HMRC recouping the lion’s share of insolvency realisations; or whether history will come to their aid by repeating itself and, in due course, seeing HMRC suffer another fall in creditor status…
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