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Following the Enterprise Act 2002, the preferential status which HMRC had enjoyed in an insolvency was abolished, rendering HMRC the same as any other unsecured creditor. The effect of this was to swell the pot of assets available to be applied to all unsecured creditor claims.

Philip Hammond announced in Monday’s budget that HMRC’s preferential status is to be restored. What does this mean for HMRC and unsecured creditors?

The Budget provided that:

From 6 April 2020, when a business enters insolvency, more of the taxes paid in good faith by its employees and customers, and temporarily held in trust by the business, will go to fund public services rather than being distributed to other creditors. This reform will only apply to taxes collected and held by businesses on behalf of other taxpayers (VAT, PAYE Income Tax, employee NICs, and Construction Industry Scheme deductions). The rules will remain unchanged for taxes owed by businesses themselves, such as Corporation Tax and employer NICs.”

What does this mean in practice?

Ultimately, it may mean less money in the pot for unsecured creditors (including lenders, pension funds and suppliers), changes to borrowing terms as lenders seek to protect the effect this may have on their position – and some commentators are concerned about the adverse impact this may have on business rescue.

Whilst the proposed changes will not see HMRC returned to the preferred status it enjoyed pre-2002, the effect is to push HMRC higher up the ranking in an insolvency, enabling it to recover outstanding tax due to it ahead of unsecured creditors.

The “reinstatement” of preferential rights will, however, only apply to money paid to a company by third parties which represents tax on that payment (i.e. VAT paid by customers or PAYE/NIC paid by employees).   Under current legislation, monies representing tax received by the company which have not been accounted for prior to an insolvency event form part of the pot of money available to unsecured creditors of that company.   Those unpaid payments – VAT, PAYE Income Tax, employee NICs and Construction Industry Scheme deductions – will, under the proposed changes, be paid to HMRC out of the assets of the company ahead of unsecured creditor claims.

Payments owed by the company itself (which are often significant, e.g. corporation tax) will remain unsecured claims in an administration/liquidation and HMRC will not be able to claim those unpaid taxes as a preferential creditor (as was the position prior to 2002).

The Budget refers to the payments by suppliers etc. as monies held “temporarily on trust” by the company. However, there is no suggestion that HMRC will have to identify the tax payments or show that monies held by the company are impressed by a trust in order to be able to claim monies as a preferred creditor. Instead, it is likely to be the case that HMRC will simply be able to claim for the full amount of the unpaid “third party” taxes from any available assets in the insolvency ahead of unsecured creditors, albeit subject to the usual order of priority of payments which applies on an insolvency.

The proposed changes are subject to further consultation but insolvency practitioners, businesses, lenders, suppliers and pension funds will all be keen to ensure that the change does not cast a shadow on business rescue.