The government plans to make HMRC a preferential creditor for certain taxes in formal insolvency processes from 1 December 2020. HMRC currently ranks as an unsecured creditor and has done since the introduction of the Enterprise Act 2002. Under the new legislation taxes collected by the business on behalf of other taxpayers (including VAT, PAYE income tax, employee National Insurance Contributions and student loan deductions) will rank as a secondary preferential creditor, payable after debts secured by a fixed charge, the expenses of the insolvency practitioner and ordinary preferential creditors (employees), but before debts secured by a floating charge and debts owed to unsecured creditors.
The rules relating to taxes owed by businesses themselves (corporation tax and employers’ National Insurance Contributions) are unchanged.
Impact on lenders
The change in HMRC’s status is likely to have a big impact on certain classes of creditors and lenders in particular should carefully consider the effect on the recoverability of their loans. HMRC is very often the largest creditor in an insolvency and the change in legislation effectively moves elements of HMRC debt up the ranking of creditors, potentially reducing the return to both floating charge and unsecured creditors.
This effective devaluation of floating charge security is expected to be keenly felt in the Asset Based Lending (“ABL”) industry. The assets secured by a floating charge are usually current assets such as a receivables ledger, cash or stock, assets that ABLs often rely upon for their security. Consequently, ABLs are likely to have less confidence in their security under the new regime, which could have a significant impact on the ABL industry and its customers going forward.
HMRC’s response to the pandemic
The position for lenders has been further complicated by government measures introduced to combat the impact of the Coronavirus pandemic on businesses. The government has announced that businesses will not have to make VAT payments during the period from 20 March 2020 until 30 June 2020 because of the Coronavirus pandemic. Businesses now have until 31 March 2021 to pay liabilities that would have been due in this period. Businesses can only defer:
• Quarterly and monthly VAT return payments for periods ending in February, March and April 2020;
• Payments on account due to between 20 March 2020 and 30 June 2020; and
• Annual accounting advance payments due between 20 March 2020 and 30 June 2020.
This is likely to further worsen the floating charge lender’s position; not only will HMRC have secondary preferential status (for certain taxes) from December but they may also have a larger outstanding balance at that time because of payments being deferred.
How should lenders react?
Robust and realistic Management Information (MI) is likely to be more important than ever. Lenders should fully understand the tax position of the clients in their portfolio. If it is considered that the floating charge security has been devalued to the extent that the lend is no longer viable on a typical ABL basis (secured against floating charge assets) ABLs may look to change their business model and lend against assets that can be secured with a fixed charge. This may well influence the type of insolvency process favoured by ABLs to recover their debts.
Knowledge is likely to be key to giving ABLs confidence about their lends. A pragmatic step to achieving this is likely to be engaging a reputable firm to prepare an Independent Business Review (IBR) where clients are carrying a lot of crown debt.
How should directors react?
Any director who gave a personal guarantee in support of a company entering into a borrowing facility, perhaps confident that it would never be called upon, should take a moment to reconsider the position. If the relevant HMRC debts have crept up to the point where in the event of an insolvency HMRC would receive the lion’s share of the floating charge assets, there is now an increased risk of their personal guarantee being called upon.
Of course, these concerns only arise if the company goes into insolvency on or after 1 December 2020. Any director who knows or should know that a company is or will probably become unable to pay its debts as they fall due has a duty at common law to act in the interests of the company’s creditors as a whole. Any director whose company falls into that category, or who is unsure about whether the company falls into that category, should take professional advice.