Should directors be concerned about return of HMRC Crown Preference?

The Golden Globe Award-winning Netflix series is not the only ‘Crown’ returning prior to Christmas 2020. HMRC’s preferential creditor status is also being restored on 1 December 2020.

First announced as part of the Autumn Budget 2018, the Chancellor had intentions to reintroduce Crown Preference with effect from 6 April 2020. However, following a general election last year, the legislation was never passed, until now. Some would question why it has been brought in after much delay, with the ongoing impact of COVID-19 and Brexit on the economy, but the Government estimates that this preferential creditor status would increase recovery of taxes by approximately £185 million each year.

It is essential for directors to be aware of the impact this will have on their businesses, particularly during this testing economic period.

What will change?

In the event of a formal insolvency, HMRC would usually rank as an ordinary unsecured creditor. From 1 December 2020, HMRC will now rank as a preferential creditor. This changes the order in which payments are made from the assets realised in an insolvency process. HMRC tax debts include: VAT, PAYE, income tax, CIS, employee NIC and student loan repayments. Corporation and employer national insurance contributions will continue to rank as unsecured creditors.

The distributions would ordinarily be paid to creditors in the following order:
1. Fixed charge holders, e.g. bank lending tied to a specific asset
2. Preferential creditors, e.g. unpaid wages and holiday pay
3. Floating charge holders, e.g. bank lending tied to a general type of asset
4. Unsecured creditors, e.g. suppliers and HMRC
5. Shareholders

From 1 December 2020, the order will be:
1. Fixed charge holders, e.g. bank lending tied to a specific asset
2. Preferential creditors, e.g. unpaid wages and holiday pay
3. HMRC preferential debts
4. Floating charge holders, e.g. bank lending tied to a general type of asset
5. Unsecured creditors, e.g. suppliers
6. Shareholders

As HMRC will sit ahead of floating charge holders and unsecured creditors, the funds available for distribution will be significantly reduced as part of an insolvency process. A further concern is that HMRC’s claim will be for the entire sum due from the Company and this is no longer limited to 12 months (as it was prior to 2003). Clearly this may lead to directors rethinking their insolvency strategy. If a director is aware their company has become insolvent or is concerned about the payment of creditors in an insolvency process, they should seek legal advice at the earliest opportunity to avoid personal liability.

Why should directors be concerned?

In the current economic climate where companies are struggling to restructure and trade due to COVID-19, the impact is likely to be colossal.

When a company experiences financial difficulties but the directors believe there is a real prospect the company’s position will improve, it will likely look to lenders for assistance. Due to the return of HMRC preference, lenders (particularly those who are asset-based) will look to increase their security provisions due to the increased risk placed upon on their debt in the event of an insolvency. In turn this will make it more difficult for businesses to obtain finance.

We are also likely to see an increase in personal guarantees being required from directors and lenders requesting fixed charge securities. This is of particular concern to directors as it increases their financial risk and personal liability. In a formal insolvency process, the liability for the loan under a personal guarantee will be passed to the director personally. In addition to this, it may become more difficult to restructure and rescue businesses as it often requires finance to assist with cashflow.

What should directors do?

Directors should keep themselves appraised as to the financial position of their company. This includes ensuring HMRC is paid on time and as and when due.

Directors may find they are required to keep lenders appraised as to sums due to HMRC, and all lenders will be forced to carry out heightened due diligence on new clients. This will no doubt impact the cost of borrowing.

The question remains, in light of the clear impact this will have, is £185 million worth it? Perhaps Mr Sunak now has little choice in the matter.

If you would like to discuss the content of this article further or are concerned by the introduction of HMRC preference, please contact Aman Sehgal.