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Protecting your taxes in insolvency

Author

Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Protecting your taxes in Insolvency

Protecting your taxes in insolvency – Current position

At present, HMRC is an ordinary creditor ranking below preferential and secured creditors (but above the shareholder or individual who operated the insolvent business). As such, HMRC will only generally receive any outstanding taxes once those ahead of it in the queue receive their distributions.

The decision to scrap the previous position known as the Crown Preference was taken as part of the Enterprise Act 2002.

It should be noted that HMRC does have powers in relation to both VAT and PAYE to transfer a liability – including where the director has run the business with impropriety. As you would imagine, these powers are restricted as one is essentially ‘piercing the corporate veil’.

Protecting your taxes in insolvency – proposed changes

The proposed changes act to allow HMRC to jump the queue of creditors.

Under the proposals, it will sit as a secondary preferential creditor.  This will mean that it will be paid out after those with secured debts and employees who are owed their wages.

However, HMRC will have priority over other trade non-preferential creditors. Further, it will also rank equally with other preferential creditors meaning their right to a distribution of the remaining assets will be reduced.

We set out our thoughts [Read More] as part of the consultation A key concern was that it appeared that the changes would be retroactive. Indeed, it seems that most of the other 41 respondents felt the same:

Most respondents commented that the proposals should be limited to tax debts arising on or after 6 April 2020 rather than insolvencies commencing on or after that date.

However, our fears over the retroactive nature of these measures, in that they act to dilute creditor rights existing prior to April 2020, is being ignored:

The government will apply this change to insolvencies where the relevant date for making preferential claims is on or after the 6th April 2020, i.e. insolvencies that begin on or after that date.

Of course, the justification for this is a pretty thin and disingenuous moral case:

As the objective of this change is to ensure that when a business becomes insolvent, more of the taxes paid in good faith by that business’ employees and customers will fund public services, rather than these being distributed to other creditors…”

Our view is that a creditor with existing rights will see this as plainly unfair.

The Enterprise Act 2002 (“The Enterprise Act 2002”)

These proposals essentially overturn what was described as one of the ‘important and integral’ aims of the Enterprise Act.

In July 2001, The Rt Hon Patricia Hewitt MP as Secretary of State for Trade and Industry published a report called Productivity and Enterprise: Insolvency – A Second Chance’ This White Paper was a forerunner to the Enterprise Act.

In the Executive Summary, it concluded that:

Finally, as an important and integral part of our proposals, we shall proceed with the abolition of Crown preference in all insolvencies a step which will bring major benefits to trade and other unsecured creditors, including small businesses

This was further elaborated upon in the main body of the White Paper:

2.19Finally, as an important and integral part of this package of measures, we will proceed with the abolition of Crown preference in all insolvencies. Preferential claims in insolvency originated in the late 19th century, but in recent years the trend in other jurisdictions has been towards restricting or abolishing Crown or State preference as, for instance, in Germany and Australia. We believe that this is more equitable. Where there is no floating charge-holder, the benefit of abolition will be available for the unsecured creditors. Where there is a floating charge-holder (in relation to a floating charge created after the coming into force of the legislation), we would ensure that the benefit of the abolition of preferential status goes to unsecured creditors. We will achieve this through a mechanism that ring-fences a proportion of the funds generated by the floating charge.

2.20 The preferential status of certain claims by employees in insolvency proceedings, such as wages and holiday pay within certain limits, will remain, as will the rights of those subrogated to them.

The reasoning here is simple. If HMRC has no preference, then other businesses in the supply chain will have a stronger call on the assets of a business in the unfortunate event of a business failure. It may enable them to recover a greater amount of the debts owed to them which will allow them to pay their suppliers, employees and also allow them to meet their own living costs.

Of course, the abolition of Crown Preference passed through both Houses and was enacted in the Enterprise Act. The Explanatory Notes to the Act state:

721.The White Paper ‘Productivity and Enterprise: Insolvency – A Second Chance’ made a commitment to abolish the Crown’s preferential status in insolvency, and to ensure that the benefit went to unsecured creditors for companies that have given floating-charges after the provision has come into force.

722.As a preferential creditor, the Crown can currently claim its debts from an insolvent company or bankrupt estate ahead of secured creditors, who hold a floating charge, and unsecured creditors…

723.The Act will abolish the Crown’s preferential status…

Indeed, it is staggering that the Summary of Responses document published on 11 July 2019 does not once mention the Enterprise Act. This is despite the fact that the legal status they seek to overturn was seen as such an ‘integral part of’ that Act.

HMRC should be made to set out the case for ‘rolling back’ these provisions and they should be properly debated in Parliament rather than under the cover of the Finance Bill.

Impact Assessment

The Impact Assessment notes that by 2022/23 these measures will bring in £185m per annum. Clearly, this must be at the expense of business owners and other hard-working people whose creditor rights have been displaced.

Conclusion – protecting your taxes in insolvency

Of course, if one asks a creditor whether he, she or it wishes to be at the front of the queue then one should not be surprised if the answer is ‘yes’.

HMRC is now tasked with ‘maximising revenues’ and therefore it is unsurprising that it wishes to be further forward in the queue.

However, HMRC presents no good reason for it other than the bland assertion that This change will enable a larger proportion of those taxes that have been paid to fund public services be used as intended.” Of course, this is overly sweet window dressing.

There will be clear implications for supply chains of which there has been very little consideration. It will, of course, have a negative impact on the supply chain and the ranking of other creditors of the Company – whether preferential or unsecured. These are likely to be productive, ordinary members of society. They will undoubtedly be dis-advantaged by these measures. This was a specific reason why the provisions in the Enterprise Act were introduced in the first place. Any reinstatement of Crown Preference would be anti-enterprise.

There is no discussion of the Enterprise Act in either the original consultation document or the recently published response document.

Again, as HMRC are the main beneficiary of its reversal, this is not surprising.

Further, the restoration of Crown Preference would be out of kilter with other jurisdictions who do not have a similar concept. As such, these provisions are a retrograde step.

It should be noted that the conclusion of the House of Lords Economic Affairs Committee report ‘HMRC Powers: Treating Taxpayers Fairly’ is that HMRC’s powers have been granted disproportionately at the expense of taxpayers. We believe that the proposed measures would be a further example of this.

These proposals are unacceptable and, with respect, represent a further ‘land grab’ by HMRC to obtain further powers to maximise revenue at the expense of productive members of society – in other words business owners and entrepreneurs who are the drivers of the economy.

 

If you have any queries over protecting your taxes in insolvency then please do get in touch 

 

 

 

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