When a business enters a formal insolvency process, the order of payment of creditors (from the proceeds of sale of company assets) is set by the Insolvency Act 1986 (IA 1986). Preferential creditors (mainly employees of the insolvent company) have unsecured debts which, by statute, are to be paid in priority to some other debts. Specifically, preferential creditors are paid after fixed charge holders (i.e. those with a charge or mortgage secured on a specific asset, such as land) and the expenses of the insolvency but before the holders of floating charges (i.e. those with a security interest over a group of ever-changing assets) and all other unsecured creditors (such as trade suppliers).
HM Revenue and Customs (HMRC) is currently an unsecured creditor for all its debts. The Enterprise Act 2002 removed HMRC’s preferential status (abolished on 15 September 2003). It was thought this change would make the insolvency process fairer on all creditors and encourage enterprise and business rescue.
In the autumn 2018 Budget, the government said it proposed to introduce legislation in the next Finance Bill to make HMRC a secondary preferential creditor in respect of the following tax debts paid by employees and customers:
- VAT
- PAYE (including student loan repayments)
- employee NICs and
- Constriction Industry Scheme deductions
Under new rules, which the government intends will come into force for all formal insolvencies that commence after 6 April 2020, insolvency legislation will be amended to make HMRC a secondary preferential creditor but only in respect of these taxes. HMRC will remain an unsecured creditor for taxes levied directly on businesses, such as Corporation Tax and Employer NICs
In its consultation document, Protecting your taxes in insolvency, published on 26 February 2019, HMRC explained why it was necessary to regain preferential status. It argued that taxes paid by employees and customers are held by the business on behalf of HMRC and should be protected in an insolvency. This will ensure a larger proportion of the taxes paid in good faith by that business’ employees and customers will fund public services, rather than these being distributed to other creditors (such as banks). In its 2018 Budget briefing, the government estimates that this change could raise extra revenue, up to £185 million annually.
A summary of responses to the consultation was published on 11 July 2019. Some respondents, largely professional bodies, were concerned about HMRC regaining preferential creditor status, arguing that enterprise, business lending and rescue could all be undermined. Others were concerned that the measure would reduce returns for unsecured creditors, since HMRC is typically one of the largest creditors in an insolvent liquidation.
This Commons briefing paper provides an overview of the background to, and the main provisions of, this proposal to reinstate in part HMRC preferential creditor status.