From 1 December 2020 HMRC will once again rank as a preferential creditor in insolvency processes. Their preferential claim will include any outstanding VAT, PAYE, national insurance, student loan deductions and CIS deductions.

Any unpaid corporation tax will remain as an unsecured claim.

What are the practical implications of this?

In very broad terms, when an insolvency practitioner realises the assets of an insolvent company and there are sufficient funds available to declare dividends to creditors, payments to creditors are made in the following order:

1. Secured creditors holding a fixed charge – e.g. mortgagees, HP companies.

2. Preferential creditors – up until 30 November 2020 predominantly consisting of employee claims for arrears of wages and unpaid holiday entitlement.

3. Secured creditors holding a floating charge – e.g. a bank holding a debenture as security for an overdraft or loan.

4. Unsecured creditors – everyone else.

There has been an emphasis in the insolvency industry since the turn of the century to maximise the prospect of a return to unsecured creditors; representing the majority of creditors by number.

With this in mind, the Enterprise Act 2002 (as amended) resulted in HMRC’s previous preferential status being scrapped, as well as the introduction of the ‘prescribed part’. The ‘prescribed part’ is the term given to funds that would have ordinarily been made available to floating charge creditors (ranked 3rd on the list above), which are now ring-fenced for the benefit of unsecured creditors.

The whole point of these changes were to place HMRC in the same position as the majority of other creditors, such as trade suppliers, and maximise the likelihood of funds being made available to unsecured creditors, thus mitigating the detrimental impact of insolvencies on the economy as a whole.

Fast forward 17 years and this has been reversed…

HMRC will now rank as a secondary preferential creditor, i.e. after the traditional preferential creditors (ranking 2nd), but before the floating charge creditors. This will naturally see an increase in the level of funds returned to HMRC in an insolvency process.

What will be the long term impact on the economy?

It is of no surprise that HMRC are very often one of the largest creditors in any insolvency process. With deferred VAT bills, an increase in time to pay arrangements, as well as a ‘comfort blanket’ being offered to directors of insolvent businesses that have continued to trade since March 2020, the level of HMRC debt is likely to be at a record high.

Many insolvent companies are currently clinging on to existence to benefit from government schemes and initiatives, now running until at least the end of December 2020. This will mean that when the schemes come to an end and when, what many insolvency professionals predict will be a ‘wave’ of insolvencies occurring in 2021, HMRC will be best placed to receive a return.

Unsecured creditors are less likely to recover funds from an insolvency process. This will result in an increase in bad debts and a consequential ‘domino effect’, which is always a bad thing for the economy.

Would you like some further information?

If you would like some more information on how these changes are likely to affect insolvencies in general, please do not hesitate to contact us.