Published: 22nd December 2020
Following the accession of the Finance Act 2020, HMRC have had their second preferential creditor status restored. This means that when a company goes into liquidation owing money to HMRC, they will now take priority over other creditors for certain outstanding taxes.
When a company enters an insolvent liquidation process such as a Creditors’ Voluntary Liquidation (CVL), all its assets are identified and sold for the benefit of creditors. The proceeds are then distributed to outstanding creditors according to a designated hierarchy as set out in the Insolvency Act 1986. Secured creditors – those which hold a charge over a particular company asset or class of asset – get paid first, with unsecured creditors sitting at the bottom of the pecking order.
Before the amendment, HMRC was classified as an unsecured creditor, ranking alongside trade creditors, credit card providers, banks, and other unsecured lenders. As of 1st December 2020, however, HMRC have been reclassified as a secondary preferential creditor, regaining the status it lost following the implementation of the Enterprise Act, 2002.
In real terms, this means HMRC will now jump ahead of both floating charge and unsecured creditors when distributions are made following liquidation. Simply put, HMRC will receive funds that would otherwise have been shared amongst unsecured and floating charge creditors prior to this change in status.
It is important to note that HMRC will only be treated as a preferential creditor in relation to certain outstanding taxes. This is limited to tax which has been ‘paid’ by employees and customers through the business, such as PAYE, VAT, employee NICs and Construction Industry Scheme (CIS) deductions. Another point of note is that the age of these tax debts does not matter, all outstanding arrears which fall into this category will now be given preferential status.
For tax which is owed directly by the company, such as corporation tax, HMRC will retain its unsecured creditor status.
As one of the largest creditors of companies in the UK, HMRC’s elevated creditor status is set to have a huge impact on the recovery prospects of unsecured lenders following liquidation. Returns for unsecured creditors are already low; it is expected this will cut returns even further for those lending on an unsecured basis.
Those lending on an unsecured or floating charge basis may therefore become more hesitant to provide borrowing on these terms as the chance of recovering money owed from a company which is subsequently liquidated is now even more slim. This has the potential to make borrowing on unsecured terms both more difficult to obtain and also more expensive in order to compensate for the additional risk and anticipated losses.
This does not just affect company’s looking to take out new finance; existing lending facilities are also in danger of being withdrawn in some instances if adequate security cannot be provided by the company’s directors and/or shareholders to satisfy lenders.
The likely outcome is that banks and other unsecured lenders will require additional security to be provided in the form of a personal guarantee from the company’s directors before lending will be agreed. A personal guarantee functions as an added level of security for lenders, providing another channel of recovering money owed should the company be unable to repay.
Once a business is incorporated as a limited company, it is given what is known as limited liability, meaning that the company is treated as its own legal entity, distinct from that of its owners. This means that any borrowing taken out by the company belongs to the company itself rather than the directors or shareholders. In the event that a limited company becomes insolvent and subsequently enters liquidation, the company’s directors will not be expected to contribute to any financial shortfall or company debts which remain.
A personal guarantee, however, put the onus on the directors to repay outstanding borrowing if the company is unable to do so. Following a company going into liquidation, the personal guarantee will crystalise, and responsibility for paying the remaining balance of the debt will shift to the director(s) who provided the guarantee.
For more information on the change in HMRC creditor status and to obtain expert advice if you feel this may affect your company, call one of our team for a free same-day meeting. Begbies Traynor is the UK’s largest professional services consultancy and operates from an extensive network of offices around the country.