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On 1^st December 2020, the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations came into force. Under the Regulations, HMRC will be a secondary preferential creditor in all insolvencies commenced on or after this date.

Before this, HMRC ranked as an unsecured creditor. The change in rank will mean floating charge creditors, which often include lenders and other financial institutions, and unsecured creditors will now rank behind HMRC.

What tax debt is recoverable by HMRC?

The following debts will be recoverable by HMRC under the Regulations to the extent that the debtor company must, by statute, deduct them from a payment made to another person (for example, an employee) and pay them to HMRC to be credited against that other person’s (the employee’s) liability.

• PAYE
• Construction Industry Scheme Deductions
• Employee National Insurance contributions
• Student loan repayments

VAT will also have secondary preferential status and there is no time limit on the debt outstanding, so tax liabilities dating back for any amount of years can be recovered by HMRC.

These taxes are concerning as businesses across the UK have been under considerable financial strain as a result of the pandemic. Government schemes such as the VAT deferral scheme mean that more businesses than usual have larger outstanding tax debt owed to HMRC.

What does this mean for lenders?

Lenders often include a debenture in their security package for a loan to a corporate borrower or where there is a corporate security provider. The debenture will include a floating charge.

Now that HMRC will rank ahead of these lenders, the funds available to distribute to lenders will be more depleted and the lender will be more exposed with less chance of recovering all of its debt. Considering the economic backdrop of the Regulations and the addition of government schemes such as the VAT deferral scheme, the raise in rank of HMRC cannot be ignored by lenders.

Not only will there be less to repay lenders in insolvency proceedings after HMRC have recovered their tax debt, but the involvement of an HMRC claim will lengthen insolvency proceedings and delay repayment to lenders.

How should lenders change their systems and processes for new customers in light of the Regulations?

Going forward lenders should consider the tax status of customers at origination and include ongoing monitoring and reporting obligations in loan documentation. Some practical steps for a lender are considered below.

Customer origination:  

Lenders should include tax status as part of early due diligence. It is advisable to review a potential customer’s tax position, consider any outstanding tax liabilities, any deferral arrangements with HMRC or any history of such arrangements and consider how these factors may impact floating charge security or whether fixed charge security is more appropriate.

Ongoing monitoring and reporting requirements:

During the term of the loan, lenders should include reporting or notice obligations in respect of certain tax events. These might include requiring a customer to notify the lender:

• of any correspondence with HMRC,
• prior to entering into any arrangements with HMRC,
• of a tax liability that has remained outstanding for a certain period of time,
• when a tax liability reaches a certain amount,
• of a change in tax status, or
• if any of their customers has a change in tax status.

By reviewing and monitoring customers’ tax status at origination and throughout the term of the loan, lenders are better equipped to assess the impact of the tax liability on the value of a floating charge or whether fixed security should be sought.

The lender is better placed to plan ahead and avoid insolvency proceedings where possible. Where there is a higher risk of tax liability, a lender might consider increasing their loan fees to offset the risk.

What about existing loans?

Lenders with floating charges in existing security packages should consider their customers’ existing tax status, any outstanding tax liabilities and the impact of the Regulations on what is likely to be recovered in the event of insolvency.

Where it would not be favourable to a lender for the customer to commence insolvency proceedings, other options could include voluntary re-organisations or restructuring.

Summary

• The Regulations place HMRC ahead of floating charge creditors which impacts lenders holding debentures by reducing the proportion of debt that may be recovered and delaying when it will be recovered. At a time where more businesses have larger outstanding tax debt owed to HMRC, this change cannot be ignored.

 

• Existing loans including debentures should be re-assessed to consider the impact of the new ranking in the event of insolvency. Where insolvency seems likely, alternative options such as re-organisation or restructuring may be more favourable for a lender where it will not recover all of its debt from fixed security.

 

• Tax status and tax liabilities of potential customers should be considered in the due diligence process at origination. Loan documentation should also include reporting requirements in the event of a change of tax status of the customer to allow for ongoing monitoring.

How we can help

If your business is at risk of insolvency, our Business Restructuring & Insolvency team can provide tailored, expert advice. Contact us on enquiries@lawstep.co.uk for more information.