New legislation will be introduced in the Finance Act 2020 to give HM Revenue & Customs (HMRC) preferential creditor status in respect of VAT, PAYE, employee NICs and Construction Industry Scheme (CIS) deductions.
These new rules were originally announced in the 2018 Autumn Budget and will come into force for insolvencies commencing on or after 6 April 2020.
We take a look at some of the practical issues that may arise, as well as potential actions that should be considered by lenders and borrowers.
Commencement and time limits
For insolvencies commencing on or after 6 April 2020 there will not be a cap on the age of tax debts that attract preferential status. Therefore, tax debts accruing before 6 April 2020 (potentially debts up to 20 years old in relation to cases of fraud) could still have preferential status in a subsequent insolvency.
In the run up to the 6 April 2020 ‘cliff edge’, lenders will need to consider their existing customers’ tax status, in particular, those known to be in financial distress, operating in challenging sectors where there are large regular payments of applicable taxes due to HMRC, or where ‘aggressive’ tax planning has been implemented in the past.
This will include considering whether there are any matters, such as open inquiries or litigation, that could be included in HMRC’s preferential claim in the event of an insolvency, diluting the floating charge holders’ recovery.
Lenders will need to assess and model the risk of HMRC debts eroding security value, whether that is in the context of pre-lend reviews or option reviews.
Origination and credit procedures
The value of a floating charge security will be eroded by any tax debts. As such a borrower’s tax profile and attitude to tax will become more relevant to lenders.
Lenders will need to consider how the tax position of the borrower may impact upon matters such as:
Security values and how these may be maximised
The pricing of facilities to compensate for increased risk
Perfecting, supplementing or taking fixed charge security
Notification obligations that should be placed on borrowers if there is a change in tax status that may impact upon floating charge security (eg late payment of a tax debt)
Review and monitoring of customers’ tax affairs
If there are particular tax risks in a customer’s business or if a business is anticipating difficulties in satisfying its tax obligations lenders should take steps to mitigate that risk.
As noted above, any tax matters that could impact the value of their security, either as part of their pre-lend review, or on an ongoing basis will be of particular significance. This may include having visibility of a borrower’s open enquiries from HMRC, whether they are considering a time to pay arrangement with HMRC to defer tax payments, or any other tax planning more generally (especially where that planning must be disclosed to HMRC under its Disclosure of Tax Avoidance Schemes legislation).
Where tax risks are identified lenders should consider any actions that could reduce their risk, such as regular briefing on status, holding additional reserves in lieu of tax or, if appropriate, obtaining tax insurance.
If a borrower is suffering financial distress, this may change the options available to secured creditors, for example, enforcing may reduce the return compared to a consensual restructuring.
Putting a business into insolvency is not a decision that is taken lightly, but lenders need to protect their position and minimise their exposure to losses. HMRC’s preferential status is one more factor to consider when exploring a way forward and could make some previously viable options less attractive to the secured creditors.
In an insolvency, HMRC will need to engage with insolvency practitioners to quantify and agree its claim, including providing tax clearance before funds can be released to the floating charge and unsecured creditors.
It is unclear how HMRC intends to engage in insolvency processes, especially where it is required to vote. In addition, it will be even more important for HMRC to give meaningful clearance to insolvency practitioners that all tax matters have been addressed and that it has no objection to the distribution and subsequent closure of the case.
Currently, HMRC can take several months to give tax clearance (if at all) and this could lead to delays in distributions to floating charge holders and other creditors. Creditors will need to take this into account in their expectations of the timing of distributions out of insolvency.
In summary, while there are currently many political uncertainties, HMRC preference appears to have cross party support. Therefore, this measure is unlikely to be affected by any change in government and should be factored into lending decisions now, especially given the retrospective nature of the rules.