It has been flagged for two years that the Government intended for HMRC to move back up the pecking order for insolvency dividends.
What is a preferential creditor?
The Insolvency Act 1986 (“the Act”) defines preferential debts that can be claimed in both corporate and individual insolvencies, giving debts that would otherwise be unsecured priority over other unsecured creditors and priority over creditors with floating charge security; such as banks.
Preferential creditors are, therefore, generally paid first in an insolvency after the costs and expenses have been settled.
What was the status of HM Revenue & Customs?
Prior to 15 September 2003, HM Revenue & Customs (“HMRC”) was a preferential creditor for, principally:
- 6 months of outstanding Value Added Tax (“VAT”); and
- 12 months of outstanding income tax and NICs.
After that date HMRC lost its preferential status and became an unsecured creditor like any other supplier to a business.
What is the position now for HMRC?
If an insolvent business entered a formal insolvency procedure on or after 1 December 2020, HMRC has regained secondary preferential status.
Only certain specified HMRC debts are included. These are:
- Pay As You Earn (PAYE) Income Tax;
- employee National Insurance contributions (NICs);
- students loan repayments; and
- Construction Industry Scheme deductions.
What does secondary preferential mean?
HMRC will still rank behind the preferential creditors, who remain as defined prior to 1 December 2020. They are, primarily, employees’ claims for outstanding wages, holiday pay and pensions contributions.
The implications for businesses
Funders with floating charge security have lent money in the knowledge that, since 2003, they would sit behind employees’ wages, holiday pay and pensions contributions in the order of priority to be paid from an insolvency. Whilst approximately 20% of what they could receive would be passed down to the general body of unsecured creditors (through the Prescribed Part) the majority of realisations, after costs, would be available to repay them. It is now highly likely that lenders will become more cautious in respect of how much they will lend and will want to know that a business is paying its taxes as and when they fall due.
Likewise, credit between business has been offered on the basis that HMRC would rank at the same level and would receive the same proportion of its debt as the trade suppliers and general creditors of a failed business. Unsecured creditors will, in future, receive less by way of a dividend than they have done since 2003 and, therefore, it is understandable if credit becomes harder to obtain. This is often the life blood of a new business that does not have significant working capital on day one, or a business that is experiencing a period of growth.
Click for our Guide to HMRC preferntial status to print and keep.