HMRC becomes preferred creditor in insolvency

Louise Brittain profile image

Louise Brittain, Partner

Louise is a Partner at Wilkins Kennedy. She is head of Contentious Insolvency and specialises in high profile fraudulent and litigious insolvencies and international asset tracing.

Dec. 14, 2018

Do the Budget amendments in relation to HMRC preferential status and phoenix provisions hail a zero tolerance position being adopted by HMRC?

The Chancellor made two announcements during the Budget 2018 that in combination, could seriously hinder the turnaround and recovery industry and possibly indicate a new “zero tolerance” stance being adopted by HMRC. Firstly, it was announced that HMRC would be reinstated as a secondary preferred creditor in the insolvency process for monies due over an unlimited period of time. The Chancellor said this will “ensure tax which has been collected on behalf of HMRC is actually paid to HMRC.” 

Therefore, from 6 April 2020, when a business enters insolvency the taxes collected by the business that should be paid over HMRC, i.e. VAT, NICs, employee income tax and Construction Industry Scheme deductions, will now attract preferential status on behalf of monies due to HMRC.

The Chancellor’s second measure is to close the net on directors who use the insolvency process to avoid or evade tax. Following Royal Assent of the Finance Bill 2019-20, anyone involved in tax avoidance, evasion or phoenixism will be held jointly and severally liable for all of the company tax liabilities.

Phoenixism occurs when, in order to avoid paying outstanding tax, a company is liquidated. The debt remains with the liquidated company while the ongoing business is transferred to a NewCo, which continues trading with no tax liability.

The Chancellor announced in the Budget that company directors will be held jointly and severally liable for outstanding tax where there is a risk that the company may have deliberately entered insolvency. This could include all insolvencies where the insolvency starts with a members resolution, an application to court, or indeed a CVA proposal regardless of the circumstances. This means HMRC will be able to decide on whether tax avoidance has taken place and thereby obtain a head start on other creditors in enforcing against the directors personal assets, ahead of other company creditors.

The draft legislation that is being proposed however does not allow any appeal on the decision that will be made by HMRC as to whether there has been tax avoidance and/or evasion, but only on procedural matters.  Any appeal brought can only be made to their own internally appointed reviewer, thereby avoiding the court process currently used entirely. The danger with this is that effectively HMRC will be acting as judge, jury and executioner, and so not only will they be securing preferential status on the company’s assets but also gaining a head start on enforcing against the directors’ personal assets. In essence, any insolvency where the company is intended to be saved, or where a sale of the assets to a connected party presents the best outcome for creditors, the company will need to be mindful of the new position being adopted by HMRC.

These measures present a dual-pronged threat to business lenders. By making HMRC a preferred creditor other lenders surely will need to review their exit strategies and revise their credit risk ratings, but also even if they attempt to limit their risk though a personal guarantee on a director’s personal assets, they will certainly need to ensure that any PG is supported by security or risk finding themselves fighting with HMRC for payment.

As well as making all lenders more risk adverse, particularly to companies with less tangible assets, such as tech companies, these measures present a risk to businesses on the brink of insolvency that may otherwise have been rescued with a cash injection from a lender.

For more information or to receive advice on any of the topics covered, please contact Louise Brittain.

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