Crown preference return moves HMRC up creditor hierarchy
The government has forged ahead with its planned reinstatement of ‘crown preference’, launching a new consultation on HMRC’s higher position in the creditor hierarchy.
In last year’s Budget, the government announced it would introduce legislation in Finance Bill 2019-20 to make HMRC a secondary preferential creditor for certain tax debts paid by employees and customers.
It marked a return to crown preference. In insolvency procedures, creditors are repaid according to a strict hierarchy. Given the nature of insolvency, a business is unlikely to fully repay its debts. The lower you are in the pecking order, the less you recoup.
Crown preference, as the name suggests, pushes HMRC higher up the creditor hierarchy for the distribution of assets in the event of insolvency -- but only for taxes held by a business (this include individuals and partnerships) on behalf of their customers and employees.
Crown preference was abolished in 2002 because critics argued it was making HMRC trigger happy, sending out winding up petitions against companies capable of rescue. The Treasury, it was also argued, could sustain a loss far more capably than an unsecured creditor.
But the consultation document argues that the government has a responsibility to the public purse to recoup all of the taxes paid by customers and employees in “good faith”. “Taxes paid by employees and customers do not always go to funding public services, if the business temporarily holding that money goes into insolvency before passing the tax on to HMRC. Instead, they often go towards paying off debts to other creditors.”
HMRC will become a “secondary preferential creditor” for the specific taxes paid to a business by employees and customers, and any interest or penalties arising from such debts.
This places the tax authority ahead of holders of floating charges (mainly financial institutions) and other non-preferential unsecured creditors, but remains below holders of fixed charges (also primarily financial institutions) and higher-ranking preferential creditors.
The new rules will come into force for insolvencies is scheduled to commence from 6 April 2020.
Stuart Frith, president of insolvency and restructuring trade body R3, labelled the plan “short sighted” and a “cash grab”. “The government’s plan will make lending to a business on a ‘floating charge’ basis much more risky.
“‘Floating charge’ lending includes common types of lending, like asset-based lending. If things go wrong, a lender won’t get their money back – it’ll go to the Treasury instead. It’s simple: the greater the risk of lending, the less lending there is likely to be. This makes it harder to fund rescues, and limits lending options for healthy businesses.”
Frith added, “The timing of this proposal could not be worse. Little thought seems to have gone into how many businesses would fail if their lending facilities were withdrawn or reduced.”
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The government seemed to have anticipated this argument, however. The consultation document stated that although the change will “affect financial institutions”, the government “does not expect it to have a material impact on lending, and the Office for Budget Responsibility made no adjustment to its forecast as a result of this measure”.
“Financial institutions will remain above HMRC in the creditor hierarchy for fixed charges they hold over assets, and the debts they will no longer recover are a very small fraction of total lending. Bank lending to small and medium enterprises alone was £57bn in the 12 months to July 2018, compared to an estimated maximum yield of £185m a year from this measure.
“Where appropriate, HMRC will also continue to offer Time to Pay (TTP) arrangements to help viable businesses with tax debt avoid entering insolvency.”
Francois is a writer, editor and broadcaster specialising in business.