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The house always wins: the re-introduction of the HMRC preference

Posted: 16/02/2021

In measures that came into effect from 1 December 2020, the Finance Act 2020 dictates that for certain debts, HM Revenue & Customs (HMRC) will now rank much further up the chain of creditors when a company enters administration or liquidation. This is a radical change to a process that had previously ranked HMRC as an unsecured creditor for nearly 20 years.

What was the old system?

When a company enters an insolvency process, it is standard practice that debts are paid on a priority basis as set out in law. The highest ranking debts are paid first, such as debts fixed against assets eg a mortgage. Once those debts are satisfied, any remaining sums in the company are paid to lower ranks, until finally, if there are funds left, the unsecured creditors of the company are paid. These unsecured creditors are paid on a pari passu basis, which means that all unsecured creditors are paid in proportional amounts depending on the total sum they are owed, if they are not able to be paid in full.

Historically, HMRC had received preferential status as a creditor in an insolvency. This was ended by the Enterprise Act 2002 and since then HMRC has ranked as an unsecured creditor, receiving pari passu payment in line with other unsecured creditors. At the time, this was seen as a celebrated move for businesses generally, as HMRC did not eat up a large proportion of the sums owed to unsecured creditors, with those funds instead being split amongst HMRC and other creditors on an equal basis. However, this equal ranking has now come to an end.

What is the new system?

The Finance Act 2020 has undone the best part of 20 years of equal footing between HMRC and other creditors owed unsecured debts. Instead, HMRC now ranks as a new ‘secondary’ preferential creditor for a number of debts owed to it including VAT, PAYE, employee NICs and construction industry scheme deductions.

What this means now is that whereas funds would previously trickle down to unsecured creditors, where HMRC used to take a proportion of the funds it was owed, HMRC instead takes all it is owed before unsecured creditors receive anything. Importantly, whilst the HMRC second preference does not rank it higher than a fixed charge, such as a mortgage, it does now place HMRC higher than any creditor with a floating charge as well. This will reduce the value of a floating charge in an insolvency, in addition to the element carved out as a ‘prescribed part’ which has also been recently increased. It is therefore arguable that floating charge holders will fair worst from the change in HMRC’s position.

What does this mean for the future?

Whilst the Government states that the reintroduction of the HMRC preference will raise millions of funds in taxes which will be for the public benefit, in reality there are potential knock-on implications.

With a number of regular lenders preferring the option of floating charges as the method of security, it is now a very real possibility that lending rates for businesses will rise on the basis that there is now an increased risk of not receiving a full repayment of debts, as HMRC will take its share first. Indeed, companies are often unable to provide any other form of security so will have no choice but to agree higher lending rates.

Moreover, at a time when companies are already struggling, it will only add to their financial burdens if they are unable to recover larger sums or any sums at all from debtors where HMRC has taken its share off the top.

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