Proposal to reinstate Crown preference
10th May 2019
The proposal to reinstate Crown preference was announced as part of the Autumn Budget last year and came as a surprise. HMRC seeks the views of individuals, shareholders, directors, lenders, companies and insolvency practitioners on the proposal to reinstate Crown preference in part.
What is proposed?
Presently, when a company enters into an insolvency process, HMRC’s claim for unpaid taxes is an unsecured claim meaning HMRC stand alongside other unsecured creditors and its claim is dealt with on an equal footing. In simple terms, unsecured creditor claims rank behind fixed charge holders, insolvency practitioner fees and expenses, other preferential creditors and floating charge holders. The order of payment is prescribed by statute.
It is proposed that the statutory order of payments will be altered so that HMRC’s claim will rank ahead of floating charge holders in respect of tax payments due to it for VAT, PAYE, NIC (employee contributions) and CIS being taxes paid by third parties to the insolvent company. In respect of the tax liabilities of the company (income tax, CGT, corporation tax and employer NIC) those unpaid taxes will still rank and be dealt with as unsecured claims.
Therefore, HMRC will become a preferred creditor, although only in part. The preferred element of HMRC’s claim will however include any penalties and interest due and include historic debt “irrespective of how old” that might be.
HMRC’s primary justification for this change is loss of revenue, but the impact on the Exchequer’s pocket was a consideration when Crown preference was abolished. The conclusion reached then was that the benefit to creditors and business rescue outweighed that loss of revenue. So what has changed?
When will the law change?
The change will apply to insolvencies commencing after 6 April 2020 HMRC. The Crown preference was abolished in 2003 following the Enterprise Act because it was considered unfair to other creditors. The change, driven by a desire to encourage enterprise and business rescue, came alongside other changes to the insolvency process including the introduction of an out of court process to appoint administrators and the introduction of the prescribed part with the intention that the package of measures would help support the rescue of viable businesses.
What is the impact of the proposal to reinstate Crown preference?
Lenders and business rescue
At the same time as HMRC’s preferential status was abolished, the prescribed part was introduced to avoid floating charge holders receiving a windfall payment and ring fenced a pot of money for unsecured creditors out of floating charge realisations. If HMRC return to preferential status, creditors will rank behind HMRC as preferred creditor, the balance of floating charge assets will be further reduced by the increase in the prescribed part.
Changes were made with the Insolvency Rules 2016 making it easier for unsecured creditors to engage in the insolvency process and for clearer lines of communication, the addressing of issues with Pre-Pack anf time to declare dividends.
If the Crown’s preference is reintroduced whilst any return to unsecured creditors may currently only be small, reducing recovery in many cases to nil removes any interest that unsecured creditors have in the process – unless they are looking to make personal claims against directors, which is a separate subkect!
HMRC say that this change is necessary because since 2003 losses to the Exchequer have increased and taxes paid to businesses should instead of paying creditors of the insolvent business, be paid to HMRC to fund public services. Monies paid to a business are paid into the company’s bank account and are available to the company for daily use. Monies representing VAT payments or PAYE are used to fund the day to day trading of the company, and most make provision for payment for HMRC. Secured creditors are treated differently because they hold security for monies lent to the company.
HMRC is not a secured creditor and yes, the business may have received a payment from a customer representing tax due to HMRC i.e. VAT, but that payment is not impressed with a trust in favour of HMRC nor does HMRC have any proprietary right to that money.
Whilst we sympathise with HMRC, we are not convinced that a return to the old days is good news for our clients and creditors.