Contractors, are you ready to pay HMRC debts sooner if your limited company is insolvent?

It’s a while ago now, but Autumn Budget 2018 contained the still currently premature move to grant HMRC preferential creditor status in the event of insolvency, with potentially grim consequences for PSC contractors, writes Jonathan Munnery, partner at Begbies Traynor.

In practical terms, the move will push commercial finance providers to the backburner and, also from April 2020, demote company pension schemes in the hierarchy of creditors.

In revenue terms, the move is expected to rake in £60m for the Treasury in 2020/21 and £175m in 2023/24. Almost needless to say, the projections for contractors are nowhere near as positive. You can make your feelings known, as a consultation on reinstating HMRC’s crown preference is set to close on May 27th – a week on Monday. Let’s look closer at the fallout you might face.

The consequences of HMRC wanting to jump the creditor queue

The Revenue’s elevated position in the ‘Order of Priority’ means that they will get an earlier chance and a higher priority to recover tax debts from insolvent businesses. Following a timely update from insolvency body R3 which characterises the move as a misguided, frustrating ‘cash grab’ by the exchequer, the rejig is set to boost funds by over £500million over the next five years.

As this pushes the likes of commercial finance providers further down the pecking order, it also increases the lending risk because in the event of insolvency, it will take longer to recover any outstanding money, and there is a significantly higher chance of non-payment. As a result, lenders may be forced to compensate for this by amending terms, reducing the finance facility available to businesses and re-establishing what is currently classed as a ‘competitive’ market rate.

The measure could have a direct impact on the lending appetite of finance providers, raising the bar for businesses to successfully qualify for finance. And by reducing vital access to finance for businesses, it jeopardises their chances of survival, their potential to score new trade deals and secure essential finance which could help invest, enrich and expand the company.

Ageless tax debts are in scope

Prior to April 2002, HMRC enjoyed preferential creditor status, allowing them priority to recover debts dating up to one year. Following the introduction of the Enterprise Act 2002, HMRC’s preferential creditor status ended, and as a result, HMRC claims that it incurred a significant loss in comparison to the number of insolvencies.

Following the planned reinstatement of HMRC’s preferential creditor status in 2020, their right over debt repayments of any age from an insolvent business will take precedence over floating charge creditors, unsecured creditors and shareholders.  The sharp distinction between HMRC’s role pre-2002 and post-2020 is that there will be no age cut-off on the debt it will be able to recover.

This measure will allow HMRC to recover employee and customer taxes, ahead of company pension schemes, finance lenders or trade creditors in order to protect tax debts from insolvent businesses. From the perspective of HMRC, these are taxes paid by employees and customers to be put towards public services, so these should be utilised accordingly.

The new Order of Priority

If a business goes into liquidation, the order of priority which is part of the Insolvency Act 1986 sets out the order in which creditors should be paid:

1. Fixed charge creditors 

2. Insolvency practitioner

3. Preferential creditors (Note; the measure will insert HMRC here – making it a preferential creditor, shifting it from fifth in line -- unsecured creditor -- to third in line.)

4. Floating charge creditors

5. Unsecured creditors (Note: HMRC is currently here -- an unsecured creditor)

6. Shareholders

As a creditor in the bottom of the priority order, you have a larger risk of losing money as by that point, each financial avenue will be exhausted by the debtor, having made payment to fixed charge creditors, the insolvency practitioner and preferential creditors.

This finer detail raises the risk for floating charge creditors, unsecured creditors and shareholders which includes the likes of customers, suppliers and financial institutions. This is why lenders may result to tightening terms, making it difficult for new businesses to obtain finance and make their mark in the marketplace.

Business morale in a Brexit-torn era

This poorly-timed move falls in line with Brexit preparations and the departure of high-profile businesses and supply chains from the UK. As the business sector reacts to Brexit negotiations, and the ambiguity around new trade deals, the industry is needful of more home-grown start-ups which are able to operate in a post-Brexit era. If finance is then limited to entrepreneurs and new businesses, launching a business and thriving alongside the challenges of Brexit could prove to be less than fruitful.

The corresponding consultation ‘Protecting your Taxes in Insolvency’ seeks feedback from key players in the field, such as businesses, finance lenders and insolvency practitioners on how best to implement the measure in April 2020. The analysis and draft legislation is expected for release in summer 2019.

Among those businesses responding should be limited company contractors. As a PSC looking to shut shop due to dwindling funds and unmanageable costs, an early part of the insolvency process will include the repayment of debts, including outstanding HMRC taxes.

Why contractors should come forward

Well, if you were to owe money to trade suppliers or lenders, it is probable that they could be left emptyhanded, as the repayment priority is going to lie with HMRC -- the preferential creditor. If you wanted to continue working with trade contacts following the closure of your company, your facility may be reduced, or you could be denied service due to bad debt.

And if you were closing your limited company with debts due to the IR35 private sector reforms -- which are scheduled to bite at exactly the same time, it is worth noting that all remaining and realised funds would be diverted to HMRC to consolidate tax debts, prior to any lenders or trade suppliers receiving payment. This could impact any further dealings you may have with the third parties you are in arrears with. So quite rightly in our view, HMRC is urging contractors to respond to the consultation with suggestions, feedback and experiences which will help form the finer details of the legislation. It’s one invitation from the taxman that we think contractors would be wise to accept. Your input can be emailed to:

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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