Under Finance Bill 2020, HMRC will move up the insolvency order of hierarchy from unsecured creditor to secondary preferential creditor status in respect of:
- certain amounts required to be deducted and accounted for to HMRC, including PAYE and employee NICs; and
- (it would appear) related penalties and interest.
This means that HMRC will, in respect of the above items, rank ahead of holders of floating charges and unsecured creditors (with which HMRC currently rank alongside) on a business insolvency. This change will take effect in relation to business insolvencies beginning on or after 1 December 2020. For taxes owed by the business itself (for example, corporation tax and employer National Insurance Contributions), the rules will remain unchanged.
This measure, essentially a partial restoration of Crown preference (removed in Enterprise Act 2002), was originally announced by Phillip Hammond at Budget 2018. However, its introduction in Finance Bill 2020, in the midst of COVID-19, may have a greater impact on businesses than would have been anticipated when the measure was originally announced.
The various business reliefs announced by the Government over the past two weeks, together with anticipated imminent changes to the insolvency legislation (to prevent the winding up of companies and to suspend the rules on wrongful trading), will be a lifeline for business. However, it is quite probable that in some cases these measures will have the effect of deferring, rather than preventing, insolvency.
That being the case, creditors of “at risk” businesses, whose debts are not secured by fixed charges, will need to consider whether to petition for a winding up as soon as they can and prior to 1 December 2020. On the one hand, they may thereby secure recovery of a greater proportion of amounts owing to them (especially holders of floating charges who currently rank ahead of HMRC). On the other hand, they run, especially in the current circumstances, a reputational risk if they are seen as acting unfairly, particularly if, before COVID-19, the business had a reasonable balance sheet and was regarded as well run.
The position of employees in relation to this is mixed. Employees will generally still rank ahead of HMRC on an insolvency. Accordingly, on the basis that the Government-funded £2.5k maximum payment per employee (an “employer bail-out payment”) is a gross amount, the employee should rank ahead of HMRC in respect of the PAYE element. This is likely to be important if, notwithstanding the receipt of an employer bail-out payment from the Government, a business becomes insolvent before passing on the payment to the employee, as described in the example below.
Take a very simple case in which a business receives a £2.5k employer bail-out payment from the Government in respect of a higher rate (40%) employee taxpayer and then becomes insolvent before it is able to pass on that payment to the employee. If, after the expenses of insolvency and the repayment of secured creditors, the only funds the business has available for distribution is an amount equal to 60% of the employee’s gross salary (£1.5k), the employee should be entitled to payment to it by the employer of the full amount of those available funds, subject to any PAYE (and employee NICs) required to be deducted from, and calculated by reference to, that reduced amount (£1.5k).
Employees will, though, still rank behind secured creditors such as banks and asset-based lenders. There will, therefore, be a tension between the interests of secured creditors and the interests of employees. That tension has, of course, always been present. However, in the unique circumstances of COVID-19 (or its aftermath), that tension might be particularly acute and could exacerbate the reputational risk which secured creditors might run should they seek to enforce their security (even after the new insolvency order of hierarchy regime has come into force on 1 December this year). The wider implications, therefore, of any such enforcement should be carefully thought through.
Of course, matters continue to shift and movements will need to be monitored. Creditors of “at risk” companies that are not sure what to do, should obtain clear legal advice before making any changes. Please contact Michael or Patrick using the below details if you have any questions.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.