The Government aims to increase the protection of taxpayers’ interests during insolvency proceedings. They are also looking to introduce legislation that will crackdown on tax avoidance where there is a risk that the company may deliberately enter insolvency.
1. Increased Protection
A briefing paper issued by HM Treasury, shortly after remarks made during the Chancellor’s speech in the Autumn Budget, outlined new measures to protect taxpayers’ interests in insolvency. As of 6 April 2020, when a business enters insolvency, any taxes paid in good faith by its employees and customers, will fund public services rather than being distributed among the other creditors. Only taxes such as VAT, PAYE Income Tax and employee NICs, which are collected and held by businesses on behalf of other tax payers, will be treated in this way.
Insolvency Practitioners were surprised by the timing of the announcement. In April 2018 HMRC issued a discussion paper ‘Tax Abuse and Insolvency’ which did not raise these issues.
Prior to 2002, HMRC enjoyed preferential status for PAYE/NI (12 months) and VAT (6 months) debts when a business entered insolvency. Although, this changed in September 2003 under the Enterprise Act 2002. Since then, such debts have been classed as unsecured claims in insolvencies, meaning that HMRC is treated the same as other types of creditor, such as trade suppliers.
In the event of a business insolvency, creditors do not expect to be paid in full. Creditors are ranked as follows:
- Fixed charge creditors
- Preferential creditors
- Floating charge creditors
- Unsecured creditors
As of April 2020, HMRC will move from unsecured to preferential status.
The new measure is an attempt to redirect some of the available funds to HMRC, by guaranteeing it is ranked higher when it comes to prioritising the repayment of debts.
Even though they will still rank below fixed charge creditors and other preferential creditors, this means HMRC will have a better prospect of recovering some or all of any unpaid taxes.
As HMRC is moving up the rankings others will inevitably lose out. This is because there will be less money available to other creditors. Lenders such as High Street banks, which rely on their ‘floating charge’, and unsecured creditors are among those that could potentially be impacted.
In its briefing paper, HMRC states “it does not expect the changes to have a material impact on lending”. However, with lenders now facing a greater risk of not getting their money back, they will inevitably become tighter in their decision-making. While they will consider their position on a case-by-case basis, this increased level of risk may manifest itself in a change to borrowing terms, increases in the cost of borrowing, and increased difficulty in securing borrowing. Employee-intensive businesses, with high PAYE/Employee NI liabilities are particularly likely to face challenges. We could also see lenders further seeking to tighten control of assets, with the aim of qualifying as ‘fixed charge’ rather than ‘floating-charge’ creditors.
2. Tax Avoidance
Other legislative changes due to be instigated as part of the Finance Bill 2019-20, aim to prevent tax avoidance by a business by entering insolvency purposely. While the majority of businesses become insolvent due to factors outside of directors’ control, there are a small number of businesses that may look to enter insolvency deliberately with the intention of ‘dumping’ debt. For example, ‘phoenixism’ is the process of conducting the same business or trade through a number of successive companies. Each time a company enters insolvency, the business is transferred to the new ‘phoenix’ company. With this transfer a number of certain debts are left behind. Often, a large proportion of the debt left behind is owed to HMRC. By making company directors personally liable for any outstanding debts and preventing them from hiding behind a company’s limited liability, it should no longer be possible to avoid paying unpaid taxes in this way.
These changes will force the director’s hand to do what they can to repay their debts in insolvency situations, at the same time as providing a strong warning to those who intentionally choose to build up large debts to HMRC. Directors should be aware that Time to Pay arrangements, that allow struggling businesses to repay balances to HMRC over a longer period, will remain available to viable organisations facing insolvency.
However, without any draft legislation as of yet, it is hard to gauge the full impact of these changes on the insolvency process. It is essential to plan ahead and businesses going through financial difficulties should seek advice immediately. Doing so, could ensure they stay on the right side of the law and help directors avoid being found personally liable for any unpaid taxes if the business takes a turn for the worse.