Protecting taxes in insolvency – bad for business?

Protecting taxes in insolvency – bad for business?

As government plans to give HMRC preferential creditor status in company insolvency proceedings become clearer, Stewart Perry*, restructuring and insolvency partner at Fieldfisher, explains why the proposals are bad news for UK businesses

Protecting taxes in insolvency – bad for business?

The publication last month (26 February) of a consultation on government proposals to make HMRC a ‘secondary preferential creditor’ in insolvency was greeted with a poor reception from most restructuring professionals.

Under the proposals, from April 2020, when a business enters insolvency, taxes ‘held’ by businesses on behalf of other taxpayers – i.e., PAYE, employee national insurance contributions and VAT – will go to HMRC, rather than being distributed to other creditors.

Ostensibly, the plan is aimed at ensuring that tax collected on behalf of HMRC is actually paid to the Revenue.

This represents a change from the current situation, where all HMRC debt ranks alongside other unsecured creditors in an insolvency.

The Treasury has said this will ensure that up to an extra £185 million per year will reach the government.

The consultation deadline is 27 May and, depending on the outcome of this exercise, draft legislation is due to be introduced this summer as part of the Finance Bill 2019-20 and come into force on 6 April 2020.

Why there is no moral argument

To those who have been following this issue since it was first announced in the 2018 Autumn Budget by Chancellor Philip Hammond, it appears that the Treasury is seeking to regain preferential status in insolvency that it relinquished in 2003 as a consequence of the Enterprise Act 2002.

According to the government, the Treasury has recorded mounting losses as a result of this change of status and makes a ‘moral’ argument for why employees’ taxes should go to the public purse when their employer becomes insolvent.

“Taxes that have been paid by employees and customers [are] held by the business on behalf of HMRC,” the government consultation states.

“The majority of people in the UK want to pay the right tax at the right time because they believe that it is the right thing to do and appreciate that tax revenue funds public services for everyone,” it adds.

This moral argument carries no weight, however, given that the government ruled out giving preferential status to prepaying consumers in its December 2018 response to the Law Commission’s 2016 report, “Consumer Prepayments on Retailer Insolvency”.

The response was released quietly between Christmas and New Year on 27 December, two-and-a-half years after the Law Commission recommended introducing a general power for government to require prepayment protection in sectors which pose a particular risk to consumers.

It is impossible for the government to make a moral argument for such preferential status when it is shutting the door to such treatment for pre-paying consumers.

The effect on business

Aside from this apparent moral void, there is also the likelihood that these proposals, if passed into law, will have a direct negative impact on a significant section of British business.

While the Treasury expects to net £185 million annually of additional taxes from regaining its preferential status, the impact this will have on all companies that use asset-based lending to support their businesses – mostly at the SME end of the market – is likely to amount to losses well in excess of the government’s anticipated extra tax receipts.

As the consultation document shows, HMRC’s new preferential debt portion will rank ahead of any floating charge creditors (which are typically asset-based lenders, such as banks), necessarily reducing the amount such lenders will advance to their customers.

The present proposal is also that the preferential status will apply to all unpaid taxes without limit, including interest and penalties.

This means any asset-based lender will need to undertake a thorough review of all tax matters (going back 21 years), or obtain insurance to cover the risk it will not be repaid all or most of its loans, as without either of these, it will have to value its potential floating charge recovery at nil.

These lenders will also not be repaid any part of their secured debt until HMRC has confirmed to the insolvency officeholder (e.g., the liquidator) that these taxes have been paid in full.

In recent years, HMRC has not had the manpower or desire to provide such clearance, and it is unclear how the extra resource will be funded (if at all).

Such a situation would certainly impact on the amount any asset-based lender would be willing to lend, and probably push up the fees associated with secured loans.

All this comes at a time when businesses of all sizes are facing crippling uncertainty around Brexit; businesses that are having to stockpile raw materials and are feeling lending constraints acutely.

This proposal will only exacerbated the issue. It appears little investigation has been undertaken to see how many companies would fail if their facilities were withdrawn or reduced, or how tax revenue would be affected by these failures.  In their present form, it seems that the suggestions contained in the consultation do nothing to support the health of UK PLC.

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