BUSINESS FOCUS A CROWNING MOMENT FOR HMRC?
It’s bad enough that failed firms leave a wake of upset and financially hurt creditors. But when the taxman steams in, takes preference over other creditors, nothing is left for anyone else, it can leave a particularly nasty taste in the mouth.
This situation, known as Crown preference, was abolished in 2002. However, it’s about to be reinstated through the Finance Bill that is currently going through parliament. Those who trade without taking payment or security up front need to pay attention.
Security explained
According to Stewart Perry, a restructuring and insolvency partner at Fieldfisher LLP, there are broadly two different types of security, a fixed charge over immovable or larger assets, and a floating charge over moveable items or fluctuating classes of assets such as stock. The result, as Perry outlines, is that “in an enforcement scenario, the amount a secured creditor receives from the proceeds of sale of a secured asset differs depending on whether the secured asset is subject to a fixed or floating charge.” Procedurally, a receiver, administrator or liquidator selling a floating charge asset will distribute the proceeds in an order defined by law with insolvency costs first in the pecking order followed by preferential creditors (employees currently), the ‘prescribed part’, and then the floating charge holder, unsecured creditors and, lastly, shareholders. Fixed charge assets realisations are sent directly to the fixed charge asset holders. Perry says that this leads to banks wanting a fixed charge over any assets with any significant value, and a floating charge over everything else. “Banks lending against floating charge assets will want to know what creditors get paid before them in calculating the value of the security, and how risky the lending is.” Duncan Swift, president of insolvency and restructuring trade body R3, echoes Perry’s thoughts. He knows that the lower a creditor is down the hierarchy, the less of their money they are likely to get back: “Given the importance of secure access to finance for businesses, and the amount of money at stake, lenders are towards the top of the hierarchy. The more lenders see back from insolvency procedures, the more likely they will lend.” As noted earlier, under the old regime, the Crown (that is, HMRC), used to be a preferential creditor. The Enterprise Act 2002 removed that preference to, as Perry says, “drive entrepreneurship and a rescue culture - putting the taxman on the same level as other unsecured creditors. However, the government inserted the prescribed part, a percentage of the floating charge realisations that by-pass the
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secured creditors holding a floating charge and are paid to the unsecured creditors including the taxman.” This, Perry says, is roughly 20% of net floating charge monies recovered to a maximum of £600,000.
If the legislation is passed, VAT and ‘relevant deductions’ (which are understood to include PAYE, employee NICs and Construction Industry Scheme deductions) will become secondary preferential creditor debt. HMRC becomes placed second in line after employees and above prescribed part creditors. Worryingly for those lending (or trading) without security, there will be no cap to the amount or the look-back period for HMRC to reclaim tax; under the old regime, Crown preference for VAT had a six-month look-back period while for PAYE it was one year. It’s being proposed that in cases of ‘deliberate behaviour’ such as fraud, HMRC may raise assessments for the previous 20 tax years, meaning a look-back period of 21 years. Swift says the government launched a consultation on the proposals which closed in May. Despite widespread opposition, “barely any changes were made when the proposals appeared in the draft Finance Bill two months after the consultation closed.”
Firms ought to be worried says Perry: “The proposed changes will impact the potential recoveries an asset-based lender (ABL) could make on insolvency. More worryingly, it impacts on those potential recoveries by an unknown and uncapped amount, meaning it will be more difficult for ABLs to assess the value of their floating charge securities.”
Grabbing cash
In its consultation document, the government explained the reason for the reintroduction. It said: “…more of the taxes paid in good faith by its employees and customers should go to fund public services as intended, rather than being distributed to other creditors, such as financial institutions.”
Peter Windatt, a director of BRI Business Recovery and Insolvency, is equally bothered. He says that the Crown has always seen itself as an “unwilling” creditor. The distinction that he makes is that “business people choose to deal with one another and, when giving credit, accept the commercial risk that goes with that. But HMRC don’t have the same role, individuals sell items subject to VAT and the VATman expects his 20% to be put in a virtual
shoe box until he comes collecting.” And from the standpoint of a professional body, “R3,” says Swift, “has been against the government’s proposals from the outset – we can’t see any justification for the move, which will damage prospects for business rescue.” He adds that R3 surveyed members on the topic and found that 78% of respondents thought the proposals will make it harder to rescue businesses, and 85% felt that any negative impact the proposals may have would outweigh the government’s justification. It has collection and enforcement resources available to it far in excess of the majority of creditors. Some, such as Windatt, suggest that it could take action earlier in order to protect all those doing business with firms in difficulty. “Trading on, or being funded by Crown monies, should not be encouraged. However, given the £750 threshold for petitioning for a company liquidation and the economies of scale for the Crown doing this, relative to the cost to a trade creditor, I would encourage it taking greater action to quash companies that are not going to make the cut rather than see HMRC top slice any funds coming out of them upon failure.”
“Lenders,” Swift says, “may have to take out insurance on existing floating charge loans, while they will also have to review every borrower’s books to check for unpaid taxes which may pose a risk to their capital. The increase to the cost and risk of lending will make it harder for distressed businesses to restructure.”
Another potential consequence, is that lenders will ask for a greater number of personal guarantees from directors. It doesn’t take a rocket scientist to realise that this will deter business growth, as directors – understandably - will be wary of the risk to their own finances in case of insolvency of their business; SMEs are going to suffer. Windatt is blunter; he forecasts an increasing domino effect of company failures.
In conclusion
Swift is of the view that the return of Crown preference will reduce the Treasury’s tax base. “The government is shooting itself in the foot here and is also threatening deep damage to the UK economy and business landscape. If our new prime minister wishes to demonstrate his business-friendly credentials, dropping these plans would be an excellent start.” BMJ
www.buildersmerchantsjournal.net November 2019
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