What does HMRC Secondary Preferential Status mean for creditors?

As of 1st December 2020, HMRC is a secondary preferential creditor in formal insolvency proceedings. Previously, they ranked as unsecured creditors and therefore stood at the bottom of the hierarchy for repayment.

Creditors are repaid in a designated order laid down in insolvency law, and this promotion of HMRC up to secondary preferential creditor for certain tax debts, has serious consequences for some creditor groups. Unsecured creditors already stood to receive very little return from an insolvent liquidation, and HMRC's elevation to secondary preferential status has lessened the likelihood of unsecured creditors receiving a dividend even further.

So, what exactly does HMRC secondary preferential creditor status mean for other creditors, and why has HMRC’s position changed in this way?

Understanding HMRC as an involuntary creditor

Unlike suppliers and other types of creditor, HMRC are unable to choose who they conduct business with. In this way they are involuntary creditors.

HMRC is also the largest creditor in many formal insolvent liquidation processes, with most insolvent companies owing at least some money to HMRC. This means HMRC are exposed to high losses in the form of tax arrears. These may have remained unpaid for months or even years, as these types of preferential tax debts aren’t time-barred.

So, what has happened to change their position in the creditor hierarchy?

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Why are HMRC now secondary preferential creditors?

HMRC used to be a preferential creditor, but this status was removed when the Enterprise Act 2002 came into force on 15 September 2003. As a result of that change, monies that would have previously been recouped by HMRC were instead repaid to other creditors of the liquidation.

In an effort to boost the public purse, HMRC's status as preferential creditor has been partially restored, however, they do still sit behind employees’ preferential claims and their secondary preferential status only relates to certain taxes.

This includes:

• VAT
• PAYE
• Employee National Insurance Contributions (NICs)
• Construction Industry Scheme (CIS) deductions

For corporation tax debts, HMRC would rank as an unsecured creditor for the amount owed.

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What is the hierarchy for repayment in insolvency?

Creditors are grouped into categories, and the following is a broad outline of the order of repayment:

• Secured creditors with a fixed charge
• Preferential creditors - company employees
• Secondary preferential creditors – HMRC only in respect of above-mentioned taxes
• Prescribed part – a sum set aside for unsecured creditors
• Secured creditors with a floating charge
• Unsecured creditors

The appointed office-holder must repay each creditor group in full before moving on to the next.

What does HMRC’s Secondary Preferential Status mean for other creditors?

Lower returns

Secured creditors with a floating charge, and unsecured creditors, are at risk of receiving lower returns from a liquidation process due to the new HMRC creditor status. As we mentioned earlier, unsecured creditors in particular, typically receive very little in the way of return from insolvent liquidation and this move by HMRC exacerbates their position.

Reluctance to lend

Lenders holding a floating charge over a company’s asset class, such as stock, may be unwilling to lend to businesses due to the diminishing value of their security. If there’s a general reluctance to lend following HMRC’s creditor status, it could create further financial distress for companies with poor cash flow, and hamper business growth as a whole.

More personal guarantees

To mitigate their risk of lending, personal guarantees could be demanded more often by lenders who would be placed further down the hierarchy. This inflicts additional pressure on companies and directors at a time when access to funding is crucial.

Potential rise in insolvencies and job losses

More restrictions on business lending and demands for personal guarantees could create further insolvencies and job losses as businesses struggle to secure vital funding. Business creditors in the supply chain are also likely to feel the effects of their trading partner’s insolvency, introducing a risk of financial decline in other businesses.

If you would like to find out more about HMRC creditor status and what it means for your business, please contact one of the team at Real Business Rescue. We’re insolvency specialists with a network of offices around the country, and can offer you a free same-day consultation.