Insolvency Changes – New Legislation

From 6 April 2020, when a business enters insolvency, more of the taxes paid by its employees and customers, and temporarily held in trust by the business, will go to HMRC rather than being distributed to other creditors.

Legislation will be introduced in Finance Bill 2019/20 to make HMRC a secondary preferential creditor for certain tax debts paid by employees and customers on the insolvency of a business. This means HMRC will move ahead of holders of floating charges (mainly financial institutions) and other non-preferential unsecured creditors, but, remain below holders of fixed charges (also primarily financial institutions) and higher-ranking preferential creditors.

The legislation will apply to England, Wales and Scotland. For Scotland, a legislative consent motion may be required. The Government will apply this change to insolvencies that begin on or after 6 April 2020. In February, HMRC published a consultation document outlining how its new status will differ from existing rules when a business goes into insolvency. HMRC has now published the outcome of that consultation, along with draft legislation.

This reform will only apply to taxes collected and held by businesses on behalf of other taxpayers (VAT, PAYE income tax, employee national insurance contributions, and Construction Industry Scheme deductions). The rules will remain unchanged for taxes owed by businesses themselves, such as corporation tax and employer national insurance contributions.

The Government has confirmed that it will not set a time limit within which tax debts are included. The original consultation document said that any penalties or interest arisen from these taxes would also form part of HMRC’s preferential claim. However, most respondents were of the view that penalties and interest arising from tax debts should not be claimed preferentially. Views were also expressed that including penalties would increase administrative burdens on insolvency practitioners who would need to undertake significant work to challenge penalties, particularly those based on behaviour.

The Government has therefore now confirmed that these elements will not form part of HMRC’s preferential claim. (HMRC penalties and interest are aimed at encouraging compliance, and are not charges paid by employees or customers, but are charges on the business.) Any penalties or interest due on taxes which rank preferentially will be claimed non-preferentially alongside other non-preferential claims.

This measure will have no effect in relation to any insolvency proceedings commencing before the implementation date of 6 April 2020 and only relates to floating charges that are still due when a business goes insolvent. Most respondents, mainly lenders and professional advisors, commented that the measure should only apply to floating charges created after 2020. However, the Government’s view is that if the measure does not apply to pre-existing floating charges, such an approach could skew behaviour by providing an impetus to retain pre-2020 floating charges unnecessarily, as they would be deemed more valuable than post 2020 floating charges. It believes this could also distort the asset-based lending market.

While the Government anticipates some impact on creditors, it does not expect this reform to significantly impact access to finance. Financial institutions holding fixed charges over assets will remain above HMRC in the creditor hierarchy, and any debts financial institutions will no longer recover on floating charges as a result of this change would represent a very small fraction of total lending in the UK. The Office for Budget Responsibility made no adjustment to its macroeconomic forecast as a result of this measure.

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