The Only Way Is Up: HMRC to be ranked higher up the insolvency priority ladder

November 11, 2020

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3 min read

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What's going on here?

On 22 July 2020, the Finance Act 2020 received Royal Assent, meaning that from 1 December 2020 Her Majesty’s Revenue and Customs (HMRC) will once again rank as a secondary preferential creditor in insolvencies.

What does this mean?

HMRC can be one of the largest creditors in an insolvency. When a business goes insolvent, anyone who is owed money by the company is ranked in order and will only receive any available funds after the person before them has been paid. The first to be paid is the administrator and any fees associated with the administration, followed by those with fixed charges over the company’s assets. The last to be paid are typically unsecured creditors, such as customers or shareholders, who in many cases are not paid at all as there are insufficient funds to repay everyone. With HMRC now set to move up the rankings, more funds from the asset pool will go to HMRC, leaving unsecured creditors with fewer funds. HMRC will go from ranking seventh to fourth in the list of creditors and will receive funds in relation to unpaid VAT, income tax, employee’s national insurance, student loan deductions and Construction Industry Scheme deductions.

The change was announced in 2018 and is expected to raise £185m annually for the exchequer. The change is designed to put HMRC in a position to acquire more of the funds which can be put towards public spending, this can be described as “crown preference”. The total managed expenditure for public spending is expected to be around £928bn for 2020 to 2021 in the UK. This has slowly risen in recent years and it is no surprise that measures are being put in place to ensure the government can put more funds towards it to meet its total managed expenditure.

What's the big picture effect?

However, there have been calls to delay HMRC moving up the rankings of creditors. Tax professionals such as the Chartered Institute of Taxation (CIOT) have warned that HMRC moving up the priority ladder could have a negative impact. Lenders face the possibility of seeing reduced returns if a business becomes insolvent, a consequence of this is lenders may be less willing to lend. This is bad for businesses already in a position of financial distress but who may be able to save their business if given access to essential funding from lenders. Suppliers and lenders are likely to tighten the terms under which they do business with a firm because of the worry they will get less back if it fails. Businesses are still experiencing the wake and aftershock of the pandemic’s impact and it is more likely that businesses will need access to finance to survive.

During the pandemic, businesses have taken advantage of deferring VAT between the 20 March 2020 and the 30 June 2020 (see our article on that here). Businesses will now have built up “higher tax liabilities than normal”. This is concerning as businesses which are struggling and find themselves in a position of facing liquidation or administration could inevitably go insolvent, with an arguably increased risk of insolvency due to the pandemic. With these factors in mind, HMRC could be looking at directly benefiting from the pandemic. However, almost £2bn of tax paid by individuals each year never reaches the public services they were intended to fund because the business that temporarily holds them goes into insolvency. This can be seen as a positive reason for the change to happen, however, it could still cause adverse problems for businesses.

There are some tax professionals and experts which have expressed these concerns and think the change should be delayed from the 1 December 2020. The four-week lockdown in England is set to end on the 2 December 2020, during which time businesses have had to endure another period of hardship and uncertainty. The change of ranking was also going to coincide with the withdrawal of key business Covid-19 support measures, such as the job retention scheme which has now been expanded until March 2021. On this basis, it does seem right to delay the change from coming into force, potentially until businesses are in a better financial position. The reality of the situation could be that HMRC does move up the rankings and businesses have to deal with the consequences.

Report written by Harry Grice

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