Restructuring plans are a threat to HMRC’s restored preferential position in insolvency, as HMRC's debts can be ‘crammed down’ by the courts. While its preferential status only covers VAT, PAYE, employee’s NIC, and CIS deductions, these taxes often form the bulk of the debt a struggling business owes HMRC.
HMRC’s consistent argument against restructuring plans is the fact that its preferential status isn't being respected. Notwithstanding the requirement that HMRC should be no worse off under the plan compared to the relevant alternative (one of the conditions of the restructuring plan), HMRC has objected to the proposal that creditors below it in the insolvency waterfall would be paid before HMRC itself was paid in full. It's interesting to note that to date, HMRC’s argument on its preferential status hasn't been sufficient grounds for a restructuring plan to be rejected (the plans were rejected for other reasons, as summarised below). Clearly this won't prevent HMRC from making the same argument again.
The courts sympathise with HMRC’s argument that it's an involuntary creditor of a business. It doesn't choose who it transacts with, and preferential debts are monies which aren't taxes of the business itself, they're taxes the business pays on behalf of others and shouldn't be used to fund working capital. Nevertheless, HMRC does have considerable powers of debt recovery and loss minimisation that aren't open to other creditors. These include the ability to demand security or enforcing joint and several liability for debts. I expect HMRC will consider the latter very carefully in the event of business failures, especially those involving ‘pre-packaged’ administrations, such as Nasmyth.
What, therefore, is the answer? To always pay HMRC’s preferential debts in full? That seems illogical and goes against the point of a restructuring plan. There must be a sweet spot, and the key to each plan will be finding it, as it will be very case specific.
What can we learn from the Nasymyth and GAS restructuring plans?
Nasmyth’s restructuring plan was rejected as the plan itself wasn't feasible. The survival of the group was dependent on the restructuring plan being implemented and HMRC agreeing a time to pay (TTP) arrangement with various other group companies. Shortly before the sanction hearing, HMRC rejected the TTP proposal, thereby removing a crucial part of the plan.
There were two reasons the GAS restructuring plan wasn't sanctioned. First, on the basis of the valuations under the relevant alternative. HMRC, and other creditors, successfully contended that only a minor error in the estimated outcomes could result in HMRC being better off if the company went into administration. Notwithstanding this point, the judge opined that the restructuring plan wasn't fair as HMRC, being one of the in the money creditors, didn't get sufficient share of the upside (or restructuring surplus).
In both cases, the companies were aggressive in their approach to HMRC which, ultimately, led to their failure, as they're now in administration.
In my experience of dealing with HMRC, it's more likely to be supportive in difficult times if it's treated openly and fairly. This trend is appearing in restructuring plans too. In its court submissions, HMRC pointed out the poor compliance history of both Nasmyth and GAS, and the court didn't look favourably on the fact GAS’ liability to HMRC increased by almost £1 million during the process.
When talking to HMRC it's also important to look at the whole group’s tax position, not just the company the restructuring plan relates to. The courts have confirmed that HMRC’s debt across the whole group should be taken into account when considering its level of economic interest in the restructuring plan company. HMRC similarly expects businesses requesting a TTP arrangement to include tax debts of all group companies in their applications. I generally find that where a group has demonstrated a good compliance history and are transparent in their dealings with HMRC, they're more likely to get a TTP than those with a history of late returns and/or payments.
A poor compliance history and/or the assumption that HMRC will agree a TTP arrangement aren't going to help HMRC look favourably on a restructuring plan.
Fitness First has recently proposed a restructuring plan to which HMRC hasn't, yet, publicly objected to. Under the plan, HMRC is due to get its debt paid in full over a five month period, essentially a TTP within a restructuring plan. On the face of it, it's much more likely to be acceptable to HMRC than either the Nasmyth or GAS plans. However, paying HMRC in full may not always be feasible.
Hot on its heels is a proposed plan for Prezzo, where HMRC would receive a return equal to the estimated value of Prezzo’s floating charge assets (less estimated costs of realising those assets under the relevant alternative). The return it would be expected to receive in the event of a sale of those assets out of administration (the relevant alternative), thereby aiming to satisfy the ‘no worse off’ test. HMRC has already indicated its opposition to the plan, and I expect HMRC will scrutinise the company’s valuations very carefully.
Fairness should be key in both parties' approaches
Ultimately, the fairness test is likely to play a large part in restructuring plans being sanctioned, and I expect HMRC will continue to take a robust approach where it feels that a plan is unfair.
When determining whether a plan is fair, there is a careful balance to be struck between HMRC expecting to be paid in full, versus using the process to cram down tax debts or arrange for other creditors to jump ahead of HMRC, unless they're truly critical to the success of the restructured business. Where the balance lies is in the hands of the courts, but engaging financial advisers with detailed knowledge and understanding of HMRC’s approach is likely to be key to presenting an acceptable restructuring plan.
UPDATE as of 5 July 2023:
Update: Fitness First and Prezzo plans sanctioned
After the two recent rejections discussed above, the courts have sanctioned both the Fitness First and Prezzo restructuring plans. As expected, HMRC did not object to Fitness First’s restructuring plan, voting in favour of receiving 100% of its debt.
Also as expected, HMRC did object to Prezzo’s restructuring plan, arguing that the plan was not fair as, amongst other things, the company was not paying its tax liabilities which fell due while the plan was being proposed while it was paying certain other creditors in full. Prezzo argued that those creditors were critical to the company’s ongoing trade and the court agreed. Prezzo is the first case where HMRC’s argument rested solely on fairness. Under the restructuring plan, HMRC was due to receive both the amount it would have been paid had the company gone into administration (as mentioned above) plus the whole of the £2 million restructuring surplus. The court decided that the plan was fair and so sanctioned it.
It is worth noting that HMRC raised the point that it was actively considering requiring security from the company to protect it against non-payment of future liabilities. This is something which we are seeing HMRC look to do more often. Raising the funds for the security can put further strain on an already struggling business, so it is worth seeking advice should a notice be received.
For more insight and guidance, get in touch with Margaret Corbally.