Introduction
The UK Government has announced that it will be introducing legislation under which the UK tax authorities1 will move up the creditor hierarchy in English insolvency proceedings2 in respect of certain taxes paid by employees and customers3.
The Government’s intention is that HMRC will have secondary preferential status in respect of VAT4, PAYE5 (including student loan repayments), Employee NICs6 and Construction Industry Scheme Deductions. HMRC will remain an unsecured creditor for other taxes, such as corporation tax and Employer NIC. There is no limit on the amount or age of the debts due to HMRC which will have secondary preferential status. Any penalties or interest due in relation to the relevant taxes will also form part of HMRC’s preferential claim.
Impact on floating charge holders and unsecured creditors
This change is important both for the holders of floating charges and unsecured creditors7. As a result of its secondary preferential status, the debts due to HMRC in respect of the taxes covered by the reform will rank ahead of floating charge realisations and unsecured claims, and will reduce them accordingly. If the debts due to HMRC are significant, a lender may recover nothing under its floating charge, with unsecured creditors also recovering nothing.
The change will come into force for all insolvencies that commence from 6 April 2020. Lenders with floating charges should note that it will affect recoveries under both new and existing floating charges.
Criticism of the reform
The reform has been widely criticised in the market given that it may, in reality, limit lending to businesses, particularly those in distress, where the floating charge forms a significant part of the security package.
The reform also appears not to be wholly joined-up with wider proposed reforms to UK restructuring and insolvency law. If introduced, one of these main proposals would see an increase in the maximum “prescribed part” (from £600,000 to approximately £800,000) of floating charge realisations which are set aside and paid to unsecured creditors in an insolvency, further reducing floating charge realisations8.
Conclusion
A lender with the benefit of a floating charge should take what steps it can to monitor the borrower/chargor group's fluctuating liabilities to HMRC in respect of VAT, PAYE (including student loan repayments), Employee NICs and Construction Industry Scheme Deductions throughout the life of the loan in order to understand the impact of HMRC’s preferential claim upon the level of its floating charge recoveries. This is likely to be particularly relevant where such groups are in financial difficulties and in any restructuring negotiations as the different stakeholders consider their options.
1Her Majesty’s Revenue and Customs ("HMRC")
2This bulletin focuses on English companies. The position in relation to non-English entities which are the subject of English insolvency proceedings and the application of the reform to them, including possible tax implications, will depend on various factors that fall outside the scope of this bulletin. In that situation, your usual Mayer Brown contacts would be happy to assist with assessing the situation.
3More details regarding the change can be found in the Government's technical consultation on the implementation of the reform (“Protecting your taxes in insolvency”, 26 February 2019), which ran from 26 February 2019 to 27 May 2019. The outcome of the Consultation is awaited.
6National Insurance Contributions.
7The enforcement of security, including floating charges, outside formal English insolvency proceedings is a complex area and too lengthy to cover in this bulletin. If you have queries in relation to entities other than English companies subject to English insolvency proceedings, please do get in touch with your usual Mayer Brown contact.
8The Government’s response to a consultation on Insolvency and Corporate Governance published on 26 August 2018 set out the proposals in this regard.
