From 1st December 2020, HMRC will move three places up the hierarchy of creditors when companies and individuals go insolvent. This puts it ahead of prescribed-part carve out creditors and floating charge creditors. Here is what you need to know about the change.

HMRC now lines up with the FSCS

In the new “pecking order”, secured creditors with a fixed charge still have first claim on the company’s assets. They remain followed by ordinary preferential creditors. For practical purposes, this means employees owed wages and/or holiday pay.

The Financial Services Compensation Scheme keeps its third-place position. It does, however, now have to share it with HMRC, at least to a certain extent. HMRC’s preferential status only covers tax debts which relate to salary deductions and taxes deducted from customers on its behalf e.g. VAT.

Interestingly, HMRC currently retains its usual status for taxes owed directly by the trading entity, for example, corporation tax. This could, however, be a “watch this space” situation. If COVID19 sparks a wave of insolvencies and HMRC loses out on a substantial sum in corporation tax, then this may be changed.

Will this change create more insolvencies?

In principle, this change should not drive more companies into insolvency. Companies should be setting aside money to pay their taxes and therefore should not need to negotiate with HMRC. Individual freelancers, however, may be more vulnerable. There have been reports of freelancers being told to use “savings” put aside for tax before they can access Universal Credit.

It is, however, to be hoped that HMRC would show some compassion to people in that situation. It is to be expected that there will be political pressure on it to do so. There are a lot of self-employed people in the UK and they all have votes.

In fact, the change may actually give some companies leverage to fight off insolvency. If other creditors know that the FSCS and/or HMRC are going to take most of any available funds, then they may be more willing to negotiate another solution.

What does this mean for administrators?

Up until now, HMRC has shown little appetite for investigating administrator’s fees. This may, however, have simply been a reflection of the fact that they were often going to be left with little to nothing anyway. Now, however, they are much more likely to get at least something and they may decide that they want to maximise that something.

Putting pressure on administrators to minimise their fees is unlikely to be anything near as politically-sensitive as putting pressure on struggling freelancers. In fact, it may even be seen as a positive if it means that there is more money left over for other creditors.

What does this mean for business lending?

Depending on your point of view, this change could mean nothing at all or be hugely significant. You could argue that business lending is currently in such a dire state, that this change is largely irrelevant. You could, however, also argue that this change could be enough to make lenders turn down some businesses they might otherwise have accepted.

In the UK, business lending has tended to operate on a combination of fixed and floating charges. Now that HMRC is set to pole-vault its way over regular floating-charge creditors, that only leaves fixed charges and book-factoring, plus personal guarantees.

The problem with personal guarantees is that they themselves tend to require some form of security, for example, a house. Business owners might be uncomfortable going down this route, especially in the current situation. What’s more, if the housing market takes a downturn, then lenders could be left very vulnerable.

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