What does HMRC Secondary Preferential Status mean for creditors?

From 1st December 2020, HMRC became secondary preferential creditors in insolvency processes. Previously, they ranked as unsecured creditors and were placed at the bottom of the hierarchy for repayment.

Creditors are repaid in a designated order laid down in insolvency law, and this change has serious consequences for some creditor groups. Unsecured creditors often receive very little return from an insolvent liquidation, and this reduces their likelihood of receiving any dividend.

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

HMRC are involuntary creditors

Unlike suppliers and other types of creditor, HMRC are unable to choose who they conduct business with, or influence a trading relationship in the same way as other creditors. This means they are involuntary creditors.

The tax body is also commonly the largest creditor in a liquidation process, and potentially exposed to high losses in the form of taxes. These may have remained unpaid for months or even years, as the preferential tax debts aren’t time-barred.

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

Why are HMRC now secondary preferential creditors?

HMRC used to be preferential creditors, 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 as preferential creditors, and used to fund public services, typically repaid other creditor groups in a liquidation process.

In an effort to boost the public purse their status as preferential creditor has been restored, but sitting behind employees’ preferential claims and this time only for repayment of certain taxes – those collected by a company on behalf of HMRC.

This includes:

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

Corporation tax is paid directly by a company so if there are corporation tax debts, HMRC would rank as an unsecured creditor for the amount owed. This move up the hierarchy of repayment in liquidation for some taxes leaves other creditor groups at greater risk of loss, however.

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.