Despite furious backlash and the already stilting effects that COVID-19 has had on the economy this year, the government has moved forward and implemented its plans to bring back Crown Preference allowing the government to come before creditors with floating charges and unsecured claims in an insolvency.
What has changed?
The Enterprise Act 2002 saw the abolishment of Crown Preference in the UK and since 2003 tax claims have ranked as ordinary unsecured debts on insolvency, meaning money owed to HMRC came below preferential creditors and secured creditors with floating charges.
As part of the legislative changes brought about by the Finance Act 2020, from the 1st of December 2020, HMRC will become a secondary preferential creditor in insolvency appointments. Secondary preferential status will be applied to certain types of tax which a company has collected on behalf of others and is owed to HMRC such as VAT, PAYE, employee national insurance, construction industry scheme deductions and student loan repayments. This is particularly concerning in the current climate where significant VAT deferrals have been granted by HMRC as part of the COVID economic response. Tax debts owed by a company to HMRC on its own account, such as corporation tax will still rank as ordinary unsecured claims.
What effect will this have?
It is thought the reintroduction of Crown Preference could have a dramatic impact on domestic and foreign lenders. Due to the decreased amount that may now be recovered by floating charge holders and unsecured creditors, business owners fear this may in turn mean lenders are less willing to extend credit.
The security of a fixed charge or personal guarantees from directors or family members may be preferred by lenders in order provide them with an extra comfort. The reality of this for businesses means reduced liquidity and available funds and, also, exposure to personal liability for directors and family members. This is a real concern for business owners heavily relying on funding to help them get through the current pandemic.
Where lenders continue to rely on floating charges, lending criteria and security requirements may need to change. It is likely lenders will want to review the borrowers tax compliance and will want to review their tax position prior to the advancement of funds and on an ongoing basis. Borrowers may have to become more transparent in revealing their tax position as lenders may require to see evidence of tax records going back several years as a condition to the financing.
The change in legislation is said to be a hard blow for asset-based lenders who use the security provided by a floating charged to provide working capital. It is, however, hoped that on the basis that there is greater likelihood that HMRC will get paid on an insolvency, they may be more willing to agree to time to pay arrangements and may be less aggressive in making demands and issuing winding up petitions.
It is feared that, as we emerge from the current pandemic, the new legislation may curb the recovery of many viable companies and will put added pressure on directors, who will now more than ever need to understand their company’s tax position and keep their company’s financial health in check. With reports of borrowers already seeing the amount they can raise with a floating charge being the primary form of security decreasing by as much as 40 percent due to the change in legislation, the return of Crown Preference can only be seen as a blow to many in an already difficult economic environment.
In order to mitigate the impact of changes it’s vital lenders and borrowers consider the impact of the reintroduction of Crown Preference and plan accordingly.
If you are worried about insolvency or require further information please contact Blackadders Insolvency Team.
Bethany Buchanan, Trainee Solicitor
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