Fortune favours the...Crown

United KingdomScotland

The Chancellor announced in his budget that the Crown is to be re-instated as a preferential creditor in insolvency, reversing the changes brought in by The Enterprise Act 2002.

Those of us who have been practicing in the insolvency space for some time will recall that, prior to the Enterprise Act changes which took effect in 2003, HMRC ranked as a preferential creditor in insolvency. Indeed, there are others who believed that was still the case today. In fact, HMRC lost their preference as a quid pro quo to the introduction of the prescribed part – known as ‘top-slicing’ of the fund available to floating charge holders in insolvency.

The Budget Statement by the Chancellor on 29 October 2018 landed with no prior suggestion or notice that the Crown preference was to be re-instated. From 6 April 2020, HMRC will become a secondary preferential creditor in insolvency (principally behind employees and the Redundancy Payments Office) for pre-insolvency tax liabilities including PAYE, employee NI, VAT and Construction Industry Scheme deductions. Basically this will cover all pre-collected taxes (so will not include corporation tax or employer NI) for which HMRC will rank ahead of floating charge holders and unsecured creditors.

The motivation behind the policy is to ensure that taxes paid in good faith by employees and customers, which the company holds in trust before paying across to the government, go towards funding public services as intended rather than to settling other creditors’ debts. The government expects this adjustment to the insolvency waterfall to yield £185m per annum for the Treasury and has said it does not expect it to have a material impact on lending. However R3 (the Association of Business Recovery Professionals) have described the move as a “retrogade and damaging step”. There are concerns that the Revenue will pursue an insolvency solution more aggressively due to their enhanced recovery prospects.

So what does this mean for Lenders? Floating charge assets generally comprise the majority of a small/medium size company’s balance sheet. From April 2020 the realisations from these assets will go to the preferential creditors, including HMRC, before the floating charge holder. Lenders who would traditionally take only a floating charge may want to consider enhancing the security package with fixed charges (which will rank in priority to the preferential creditors) and/or personal guarantees from directors. In addition, facility terms should be policed more rigorously and more regular/better quality management information should be requested from borrowers to monitor any worsening of the Revenue’s position.

The overall effect on the economy could be that borrowing is both harder to come by and also more costly as lenders may consider increasing rates and/or reducing the loan amount to mitigate the potential additional risk. There are concerns that the changes will make business rescue much more challenging and also that the Treasury losses will be transferred to the private sector.

The government published the Summary of Responses to the Tax abuse and insolvency consultation on 7 November 2018. Interestingly this consultation made no mention of the proposed reinstatement of the Crown’s preference. There will now be a period of consultation on these changes and therefore there will undoubtedly be further debate to follow in the coming months.