A myriad of changes are coming to tax law in the UK in April. As well as changes to income tax and capital gains tax, and a new 2% digital services tax aimed at the likes of Apple, Facebook and Google, the new Finance Act 2020 will give HMRC back their old status as “secondary preferential creditors”, placing them behind only “fixed-charge creditors” and employees, should a business become insolvent or go into administration on or after the 6th April this year.
This change in policy, in what appears to be part of a wider crackdown on those who have been deemed by HMRC to be shirking paying their taxes, means that rules on preferential creditor status are to be reverted to how they were prior to the Enterprise Act 2002 being implemented in September 2003.
In short, after April 6, when a company goes bust and enters into administration or liquidation, any taxes owed to HMRC by the company on behalf of employees or customers, for example PAYE, student loan repayments, deductions for the Construction Industry Scheme or employee’s national insurance contributions that are held back from employee’s wage packets, or VAT charged to customers, will be treated second only to fixed charge creditors (ie banks and lenders who hold a claim over specific assets such as land, vehicles, property or machinery) and any wages owed to employees (although even then with several caveats), and more importantly than money owed to “secured creditors with a floating charge”, “unsecured creditors” and shareholders.
At the moment, before the new rules kick in, HMRC have been classed as unsecured creditors in all cases, meaning that in the order of preference, they are ranked alongside the likes of contractors, customers or suppliers; in other words they sit right at the back of the queue and have to first wait for employees and creditors to be paid money owing to them – only then being able to recover any outstanding taxes. For other taxes; those that are owed directly by the company to HMRC such as corporation tax and employer’s national insurance contributions, HMRC will still be treated as an unsecured creditor. These debts are often quite low in comparison to the taxes owed indirectly to HMRC like the aforementioned VAT and PAYE, so in practice preferential creditor status will actually apply to the lion’s share of money owed to HMRC.
The government reasons that debt to HMRC should be treated with such a higher degree of importance, and on a level with any debt a company owes to its own employees, because the taxes were paid “in good faith” by employees and customers, who intended them to fund public services and not to pay back a company’s creditors or shareholders.
According to some estimates, last year the government lost out on £1.9 billion in potential taxes that would otherwise have been destined for the treasury, to other (apparently less worthy) creditors. £1.9 billion a year certainly sounds a lot, but it actually works out to just over £35 million a week, a mere tenth of the savings we were promised would come as a result of our exit from the EU, and by the very same people. The government claims that with the changes, HMRC will raise an extra £185 million in revenue, but it’s not clear if they have
taken into account the fact that companies might make less money if their access to borrowing dries up as an indirect result of the changes.
Employees have always, quite rightly been classed as preferential creditors; they’ve put their own blood, sweat and tears, not to mention time and hard work into a business, only for them to be looking at the very real possibility of losing their job or maybe even their home, so it’s really only fair that they receive any wages they are owed before any other debts can be settled. HMRC always came at the back of the queue in preference of creditors, also quite rightly, as they had the least (ie nothing) invested in the business. HMRC didn’t provide funding to the business nor did they provide their labour. HMRC just sit back and take their cut; like Tony Soprano, or other less fictitious mafia capos perhaps. Should the business fall into hard times, it’s unfortunate that HMRC might lose out on potential tax revenue, but at least they didn’t actually have anything of theirs invested in the business, so they’ve lost nothing. Employees will fortunately still come before HMRC in the queue as they are considered the primary preferential creditors and HMRC secondary to them.
However, the paying back of unpaid wages to employees’ does have its limits: employees are only entitled to any outstanding salary for the four months prior to the company becoming insolvent, plus up to six weeks of leftover holiday pay and certain eligible pension contributions. If this leaves the employee out of pocket, they may be able to make a claim with the National Insurance Fund to top up the money assigned to them by the company’s administrators, however these payments are also limited at up to eight weeks’ of wage arrears, up to six weeks’ outstanding holiday pay and possibly pay in lieu of notice and redundancy pay, up to 12 weeks of pay (depending on age and length of service) and at a maximum of £547 a week. Unlike employees, there is zero cap on the amount of money HMRC can claim back from businesses in administration.
There is one other potential exception to all this in the form of the Financial Services Compensation Scheme (FSCS) who also have secondary preferential creditor status, in line with HMRC. Also it should be noted that HMRC were previously classed as secondary preferential creditors, prior to 2002, so this change is not unprecedented. It was the Enterprise Act 2002 that downgraded HMRC to unsecured creditor status.
As debts to HMRC will now have to be paid up before debts are paid back to many other creditors, and crucially, as there is no cap on the amount that HMRC can claw back unlike former employees of a failed company, lenders will potentially be heavily affected by the change. As lenders seek to protect their debts, it’s likely that these effects will trickle down to small to medium-sized enterprises, who will likely now find it even more difficult than it is currently to get access to much needed loans from newly apprehensive lenders, regardless of the government’s claims that the new rules would affect only a “very small fraction” of the total money lent to businesses in the UK, and constitute a “fair approach that balances the interests of creditors and the Exchequer”.
In fact, the reason given by the government as to why HMRC were stripped of their preferential creditor status back in 2003 was because “it was thought this change would make the insolvency process fairer on all creditors and encourage enterprise and business rescue.”
So by the government’s own reasoning, reinstatement of HMRC’s preferred status will surely discourage enterprise and business rescue!
HMRC, with their attempts to squeeze tax from left, right and centre in a misguided attempt to increase tax revenue, they might end up causing the opposite to happen, with uptight lenders and cautious businesses avoiding taking risks and making investments into future endeavours, meaning HMRC may lose out on potential taxes from the future enterprises that could have been. So, the biggest losers in this unfortunate mess will undoubtedly be HMRC themselves.
Ben Hart
Sources:
https://www.pricebailey.co.uk/blog/hmrc-preferential-creditor/
https://www.grantthornton.co.uk/insights/what-hmrcs-preferential-creditor-status-means-for-lenders/
Budget 2018: Protecting your taxes in insolvency
Insolvency: return of HMRC preferential creditor status
| Current system | After 6th April |
| Fixed charge creditors | Fixed charge creditors |
| Preferential creditors – employees | Preferential creditors – employees |
| Secondary preferential creditors – Financial Services Compensation Scheme | Secondary preferential creditors -HMRC (for example PAYE, NIC, VAT)Financial Services Compensation Scheme |
| Floating charge creditors | Floating charge creditors |
| Unsecured creditors including all debt to HMRC | Unsecured creditors including taxes owed directly to HMRC |
The text shows changes to order of preference
