HMRC Creditor Preference: Consequences for Lenders and Directors

HMRC will regain its status as a preferential creditor for insolvencies that commence on or after 1 December 2020. This change is expected to have significant ramifications for lenders who have secured their debt by way of a floating charge, and also for directors who have provided personal guarantees. It may also have indirect consequences for Company Voluntary Arrangements (CVAs).

The changes explained

As things currently stand, HMRC is classed as an unsecured creditor in relation to unpaid taxes. The new legislation will change this. The passing of the Finance Act 2020 in July this year means that from 1 December, HMRC will now become a preferential creditor; holding a position of priority above not only unsecured creditors but floating charge creditors too.

This means that HMRC will have a special claim to the assets of insolvent companies - in any liquidation or administration commenced after 1 December 2020 – at the direct expense of secured lenders and unsecured creditors.

This preferential status will only apply to taxes collected by a company on HMRC’s behalf, ergo VAT, PAYE, employee national insurance contributions (NIC) and construction industry scheme (CIS) deductions. HMRC will remain an unsecured creditor for corporation tax and any other taxes owed directly by a company.

So, the amended order of priority is:

• Fixed charge holders;
• Costs of the insolvency process;
• PRIMARY Preferential creditors (employee entitlements);
• SECONDARY PREFRENTIAL CREDITORS (HMRC – Relevant tax);
• Prescribed Part deduction;
• Floating charge holders;
• Unsecured creditors (including all HMRC debt); and
• Shareholders.

Impact for lenders in insolvency 

The impact on lenders will be immediate and is likely to be profound. Many UK businesses are experiencing higher tax debts than normal due to the struggles of 2020 and the Coronavirus support measures introduced by the government, emphasising the need for lenders to understand the tax risks and profiles of their customers.

Where a lender holds a fixed and floating charge, HMRC’s new preferential status has no impact on any assets subject to a fixed charge, but it will have a considerable effect on floating charge assets  such as stock, cash at bank, and debtors. From 1 December, HMRC will rank ahead of the floating charge for their preferential claim.
 
For lenders with no security, the probability of a return in insolvency will be reduced if HMRC has a preferential debt. In some cases, enforcing insolvency may reduce the return compared to more informal restructuring measures. Lenders considering enforcement action against defaulting debtors, such as appointment of an administrator, should consider whether this can be done before 1 December, as HMRC will not have preferential status in insolvencies beginning before this date.

With new financer arrangements, lenders will need to forensically assess the tax position of potential borrowers when performing due diligence and consider what impact it may have on unsecured debt or floating charge security.

Impact on directors and personal guarantees

HMRC are usually the largest creditor in an insolvency procedure and will now move up the pecking order above unsecured creditors and floating charge holders. This could have huge ramifications for lenders who have secured their debt by way of a floating charge and also for directors who have provided personal guarantees. Banks will see diminished value in their security, which might affect future lending and pricing, and could expose guarantors in the event of an insolvency.

In insolvency situations where directors have provided a personal guarantee, the changes could lead to more personal exposure for the director/guarantor as the lender now falls behind HMRC in the hierarchy of creditors.

Further advice

The impact of HMRC returning to preferential creditor status could be substantial, especially at a time when businesses are dealing with the huge disruption caused by Covid-19. For further advice on this issue, please contact XXXXX at Begbies Traynor Group.